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Author: 



Dawson, Sidney Stanley 



Title: 



Partnership accounts 



Place: 



London 

Date: 

1913 



9M-^aoa3'i 



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D3?^7 Dawson, Sidney Stanley • 

Partnership accounts, by Sidney Stanley Dawson,, 
and Richard Caton de Zouche... London, Gee, 
1P13. 

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of 



PARTNERSHIP ACCOUNTS. 



BY 

SIDNEY STANLEY DAWSON 

r- (Of the Finn of Da-u'son. Chevaliei I'-V Graves, Liverpool). 
Master of Commerce-University of Birmingham. 
Fellow of the Institute of Chartered Accountants in England and Wales. 

{Senijr Honoursman, Interwe.iiate F..\ (imitation, December 1H9J) 

{Senior Honoursunn, Final Examination, Decemher lf(97) 

Professor of Accounting, University of Birmingham, from 1907 to 1910. 

Author oi "The Accountant's Comi'endrm," I'tc. &c. 

Sometime Tutor to the Liverpool Chartered Accountants Students' Assoiiation ; Birmin^^ham 
Chartered Accountant Students' Society: Liverpool School of Commerce : Liverpool Institrte 

of Bankers : Liverpool Y.M.( A., &c. 



:\ 



AND 

RICHARD CATON DE ZOUCHE 

£J0/ the firm of de Zouche & Mackenzie, Liverpool). 

Associate of the Institute of Chartered Accountants in England and Wales. 

(Senior Honoursman, Intermediate Examination, June 1903) 
(Second Honoursman, Final Examination, November 1905) 

Tutor to the Lverpjol Char!er^d Accountants Students^ Association: Birmingham Chartered 
Accountant Stud,nts' Society .- University of Liverpool (Board of Le^al Studies), -v 



L(JND()N : 



Gee <Sc Co. (Publisjiers) Ltd.. 34 Mo(^Rr.ATi: STRKtr. E.G.-. 



1913 




I 



PREFACE. 



^1^1 IE aim of the Authors has been to expound the 
principles underlying Partnership Accounts in 
accordance with the provisions of the Partnership Act, 
1890, and the various legal decisions of the Courts, 
and, except so far as was considered necessary for a 
clear exposition of the Accounting problems involved, 
the discussion of purely legal points has been avoided. 
The work has been prepared primarily for the use of 
Accountant Students, upon the assumption that they 
have already acquired a knowledge of the principle of 
bookkeeping by double-entry. 

S. S. D. 

R. C. DE Z. 

'^ovpmhcr 191 3. 



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1 <S 



CONTENTS 



PrI'FACE 

• ' * • • • • • • • . • 

Contents 

Chap. I. — The Part nership A^^roement 

T> II- — 1 lif Accounts 

,, III. — I'lie Balance Sheet 

M J^ • — H^t* Profit and Loss Account 

»» v.— Treatment of Goodwill in Partnership 



„ VI. 
„ VII. 

„ vin. 

„ IX. 

Index .. 



Accounts 

Accounts upon a Dissolution — I. 



— do. 



do. —II. 
do. —III. 



111. 

V. 

I 

8 
18 

25 



do. 

Income Tax 

Accounts of Limited Partnerships 



62 

72 

98 

109 
129 



163 



173 



I I 



» 



PARTNERSHIP ACCOUNTS. 



CHAPTER I. 






I 



THE PARTNERSHIP AGREEMENT.. 

In approaching the matter of Partnership Accounts 
it is desirable to draw attention to some of the more 
important characteristics of the partnership agreement 
so far as it may affect the accounts. 

Partnership is defined by Section i of the Partner- 
ship Act, 1890, as ** the relation which subsists between 
** persons carrying on a business in common with a 
** view of profit.'* 

It is necessary to note the distinction between the 
two classes of partners now recognised by law, termed 
respectively *' general ** and ** limited." The latter 
class, the rights of which are regulated by the Limited 
Partnerships Act, 1907, and the Partnership Act, 1890, 
are not here dealt with, except in the chapter headed 
*' Limited Partnerships," and the subject of Partnership 
Accounts is, with that exception, treated as it affects 
** general " partners alone. 

A partner may, perhaps, be under all the liabilities 
and entitled to all the rights of a full partner, and yet 
be entirely passive in the conduct of the business, and 
will then commonly be known as a '* dormant " or 
*' sleeping " partner. 



B 



2 PARTNERSHIP ACCOUNTS. 

'* General " partnerships are largely governed by the 
Partnership Act, 1890, but this statute, which is a codi- 
fication of this particular branch of the common law, 
applies only as regards many of its principal provisions, 
so far as the partnership agreement does not otherwise 
provide. 

Partners fill the positions both of principal and agent ; 
principal, to be bound each by his co-partners; agent, 
to bind them, in and according to the ordinary course 
of the partnership business. In this feature of the 
partnership relationship is to be found a distinction 
from other forms of joint venture which may have, at 
the same time, the earning of profit as their common 
and primary object. 

To the creation of a partnership, agreement is 
necessary between the partners as individuals. All the 
rights, interests, and obligations of partners as such 
arise from, and are to be determined by, the partnership 
agreement. 

Partnership implies, therefore, a contract; but the 
contract need not, except so that it may be duly binding, 
follow any particular legal form. It may be under seal, 
if so desired, but will more usually be in writing not 
under seal ; it may, however, be by parol, or partly by 
writing and partly by parol. It may be entered into 
for a definite or indefinite period, according to the wish 
of the parties, and, in general, the terms to which the 
partners may agree are limited only by the Common 
Law and the Partnership Act, 1890. 









I 



PARTNERSHIP ACCOUNTS. 3 

The agreement once made is not unalterable. The 
parties are free to readjust their contract from time to 
time, with the consent of all, and their new agreement 
will become effective and operative by way of accord 
and satisfaction of the old. 

Inasmuch as the contract need follow no special legal 
form, some of its terms may exist only in the course of 
dealing between the partners, and may, perhaps, be 
evidenced in part by entries in the books of account. 
So far as third parties are concerned, every partner is 
an agent of the firm and of his other partners for all 
the purposes of the partnership business. Each partner 
may bind the firm, and, although partners may, as 
between themselves, restrict the powers of any one of 
their number, such restriction must be notified to third 
parties, or they will be entitled to treat the apparent as 
the real authority. 

The carrying on of business with a view to profit 
will usually involve the contribution of Capital by some 
or all of the partners, and the assets representing that 
capital and the other liabilities of the firm, whether to the 
partners for advances or undrawn profits or to ordinary 
creditors, will form the " partnership property.*' There 
is no implied obligation in law that partners must 
contribute capital in equal or in any stated proportions ; 
this is a matter for agreement. One partner may 
contribute much, perhaps the whole, of the Capital, the 
others little or nothing. 

Nor is there any implication in law that partners 
must give up their whole time to the partnership 

B 2 



4 PARTNERSHIP ACCOUNTS. 

business, for, in fixing the terms of the partnership 
agreement, regard will be had by all the parties to these 
and other material points. 

In considering the financial rights of partners it is 
necessary clearly to distinguish — 

Rights in capital. 

Rights in respect of advances and undrawn 
profits. 

Rights in profits and liability for losses. 

Rights in capital will be determined, originally, 
according to the amount of the partners* contributions; 
and, subsequently, by the amount appearing as due in 
respect thereof from the partnership accounts. 

According to the general theory of the Partnership 
Act, 1890, Capital is a fixed quantity — fixed, that is, in 
the sense that it is not to be varied except as and when 
mutually agreed by the partners. It is subject to the 
fortunes of the business, but, if diminished by losses, 
must be restored by the contributions of the partners 
towards those losses. If, on the other hand, the capital 
is not only maintained, but a surplus appears of assets 
over and above all liabilities, including Capital, that 
surplus is profit, and may be withdrawn by the partners 
in the proportions in which they are entitled thereto; 
for to do so will still leave the Capital intact. 

In practice, the theory of the Act is frequently in 
some measure obscured by a periodical revision of the 
partnership agreement, such revision — usually made at 
the time of preparation of the annual or periodical 



PARTNERSHIP ACCOUNTS. 5 

accounts— being by way of transfer to the respective 
Capital Accounts of the partners of the balances upon 
their Current Accounts; resulting in an adjustment to 
fresh figures, which, until further agreement, are taken 
to represent the interests of the partners in respect of 
Capital. 

Partners may advance sums over and above the 
contributions due from them in respect of Capital. 
Such further sums may, by consent of all the partners, 
be regarded as additional Capital of the partner so 
advancing, but will otherwise represent a Loan or 
Advance to the partnership. 

Such Advances carry a right to 5 per cent, interest 
by implication of the Partnership Act, 1890, Section 24, 
unless otherwise agreed. Capital, on the other hand, 
carries no such implied right, and an allowance for 
interest must be expressly agreed for. 

Advances, again, rank for repayment before Capital, 
but not in priority to the claims of ordinary creditors. 
Subject to agreement to the contrary, a partner may 
claim repayment of his Advances, but not of his Capital. 
The correctness of the distinction between Capital and 
Advances may possibly have a material effect upon the 
financial position of a partner. (See Chapters VII and 
VIII.) 

It has already been stated that in respect of profits 
partners have a right of withdrawal according to their 
respective shares. They may, perhaps, prefer to leave 



6 PARTNERSHIP ACCOUNTS. 

their profits undrawn, and possibly (by agreement) 
to regard them as distinct advances, in which case 
interest will be allowed thereon. 

Against such profits, partners may make Drawings 
on account. The partners may perhaps make Drawings 
after all undrawn profits have been exhausted by pre- 
vious Drawings and/or contributions towards losses, 
undrawn profits commonly being first used to satisfy 
such contributions; but Drawings in these circumstances 
imply a withdrawal of Capital, though often assumed 
as on account of current but unascertained profits, and 
are to be made only by agreement. 

It is a usual and convenient practice to open for each 
partner in the books a Current Account, which can 
be credited with the due proportions of gains arising, 
debited with the Drawings made against those gains, 
and charged also with shares of losses. The balances 
of such Current Accounts may, as stated, be transferred 
to the Capital Accounts periodically by agreement, thus 
increasing or reducing the amounts of agreed Capital. 

Before proceeding to a consideration of the general 
-questions affecting the accounts, it is desirable to quote 
the provisions of Section 24 of the Partnership Act, 
1890. 

rhe interest of partners in the partnership property and their 
rights and duties in relation to the partnership shall be determined, 
subject to any agreement express or implied between the partners, 
by the following rules: — 



I 



PARTNERSHIP ACCOUNTS. 



(i) All the partners are entitled to share equally in the capital 
and profits of the business, and must contribute equally 
towards the losses, whether of capital or otherwise, 
sustained by the firm. 

(2) The firm must indemnify every partner in respect of pay- 
ments made and personal liabilities incurred by him — 

(a) In the ordinary and proper conduct of the business of 
the firm ; or, 

{b) In or about anything necessarily done for the preserva- 
tion of the business or property of the firm. 

(3) A partner making, for the purpose of the partnership, any 
actual payment or advance beyond the actual amount of 
capital which he has agreed to subscribe is entitled to 
interest at the rate of 5 per cent, per annum from the date 
of the payment or advance. 

(4) A partner is not entitled, before the ascertainment of 
profits, to interest on the capital subscribed by him. 

(5) Every partner may take part in the management of the 
partnership business. 

(6) No partner shall be entitled to remuneration for acting in 
the partnership business. 

(7) No person may be introduced as a partner without the 
consent of all existing partners. 

(8) Any difference arising as to ordinary matters connected 
with the partnership business may be decided by a majority 
of the partners, but no change may be made in the nature 
of the partnership business without the consent of all 
existing partners. 

(9) The partnership books are to be kept at the place of busi- 
ness of the partnership (or the principal place, if there is 
more than one), and every partner may, when he thinks 
fit, have access to and inspect and copy any of them. 



CHAPTER II. 



THE ACCOUNTS. 

Section 28 of the Partnership Act, 1890, provides' 
as follows : — 

" Partners are bound to render true accounts and full informa- 
tion of all things affecting the partnership to any partner or his 
legal representatives. ' ' 

The terms of the section quoted, and of Sections 29 
and 30, quoted below, may be the only guide to the 
terms of the agreement between the partners, except 
such further evidence as may be adduced from their 
general course of dealing; or there may be a partnership 
agreement, drawn up in greater or less detail, as the 
necessities of the case may have seemed to require, 
providing specifically how and where the accounts are 
to be kept, when Balance Sheets are to be prepared, how 
profits or losses are to be divided, and such further 
provisions as it may have been considered necessary to 
make the subject-matter of express agreement. 

*• The account which a partner may seek to have taken may 
be either a general account of the dealings and transactions of a 
firm, with a view to a winding-up of the partnership ; or a more 
limited account, directed to some particular transaction as to 
which a dispute has arisen." (Lindley.) 

The obligation of Section 28 is towards "any 
partner or his legal representatives." The latter term 
will include not only an executor, but also the trustee 



PARTNERSHIP ACCOUNTS. 9 

in bankruptcy of a partner. It is an obligation of the 
partners inter se, and such obligations (if any) as exist 
towards third parties {e.g., creditors) other than " legal 
representatives" are to be gathered by implication, 
rather than by direct statutory authority. 

The Bankruptcy Act, 1890, for example, makes 
provision " for omission to keep such books of account 
as are usual and proper " being regarded as a ground 
upon which the Court may refuse or suspend the 
discharge of a bankrupt debtor or grant it subject to 
conditions. 

A partner must give to the partnership the full benefit 
of his trading connections, unless, of course, otherwise 
agreed. This is borne out by Section 29 of the Act, 
which is as follows : — 

Section 29. — (i) Every partner must account to the firm for any 
benefit derived by him without the consent of" the other partners 
from any transaction concerning the partnership, or from any use 
by him of the partnership property, name, or business connection. 

(2) The section applies also to transactions undertaken after a 
partnership has been dissolved by the death of a partner, and 
before the affairs thereof have been completely wound up, either 
by any surviving partner, or by the representatives of the deceased 
partner. 

There should be noted in Subsection (i) the words 
"without the consent of the other partners." The 
partners are tree to make such agreement as they wish. 
If they make no express agreement, the section applies. 

By many partnership agreements, provision is made 
that some specific source of income attributable to the 



lO 



PARTNERSHIP ACCOUNTS. 



partnership business shall be reserved, as to one or 
more of the partners, from the division of profits. Thus, 
the partners in a firm of Chartered Accountants may 
agree that all secretarial and directors' fees accruing to 
any partner other than the senior partner shall be 
regarded as partnership profits, and pooled accordingly; 
but that such fees of the nature stated as accrue to the 
senior partner be regarded as his income solely. 

So strong is the mutuality of the partnership obliga- 
tion, that if a partner, without the consent of the other 
partners, carries on any business of the same nature 
as, and competing with, that of the firm, he must 
account for and pay over to the firm all profits made 
by him in that business. (Section 30.) 

The books of account may be many or few, according 
to the nature of the partnership and the views of the 
partners. They are to be kept at the place of business 
of the partnership (or the principal place, if more than 
one), and every partner may, when he thinks fit, have 
access to and inspect and copy any of them (Section 

24 (9).) 

It is clear from the provisions of the Act : — 

(i) that accounts are to be prepared; 

(2) that they are to be inclusive of all transactions 
affecting the partnership. 

The periods to be covered by such accounts; the 
dates when they are to be taken ; the manner of their 
preparation ; the form and system of bookkeeping ; and, 
above all, the principles upon which they sere to be 
drawn, are all matters of agreement. 



i'i 



PARTNERSHIP ACCULNTS. 



II 



The partners may determine these matters as they 
think fit, but, having once agreed, they are not debarred 
from making fresh agreements as and when they desire. 

Regarding the periods to be covered by the accounts, 
these may be prepared once a year, twice a year, 
monthly, or even daily, the periods chosen being merely 
a matter of convenience. 

No special books or methods of bookkeeping 
have any statutory sanction, but it will here be pre- 
sumed that double-entry is the system adopted, and 
that the books used are such as to record the trans- 
actions easily and conveniently in accordance with this 
system. No general statement can be laid down 
regarding these matters, which are incidental and not 
fundamental. What are fundamental, however, are the 
general principles upon which the accounts of the 
partnership should be set out, so as to show (i) the 
financial position as between the partners and the firm's 
creditors, and (2) the profit or loss of the period covered 
by the accounts. 

These two objects are more or less interdependent. 

Profits, in the case of a partnership, may be said to 
be " the increase in the surplus of assets over liabilities." 
The definition in this form implies a comparison of 
the surplus in each of two Balance Sheets prepared at 
different dates. Such Balance ^Sheets must necessarily 
take account of all assets and liabilities at their existing 
values, and further, should the improvement in the 
surplus have been minimised by drawings on account 
of profits, the amount of the drawings must be brought 



r -'^ 



tf 



12 



PARTNERSHIP ACCOUNTS. 



)|M 



into account to indicate the surplus at the figure which 
would have resulted had no such withdrawals been 
made. 

To the general statement that all assets and liabilities 
must be introduced at existing values, must be added 
the explanation that existing values shall ordinarily be 
taken to mean value to the business as a going concern. 

Such assets (e.g., plant, machinery, &c.) as are not 
of everlasting value and as are not purchased for re-sale, 
but held rather for the permanent production of value, 
must be taken to lose their value proportionately to the 
services rendered by and use made of them, having 
regard to their estimated or probable effective working 
life, their first cost, and their residual value. Deprecia- 
tion, and not fluctuation, must be considered. 

It is customary, where practicable {e.g., under a 
system of bookkeeping by Double Entry), to prepare 
a record of gains and losses concurrently with the 
Balance Sheet, and the balance of the Profit and 
Loss Account so prepared is entered in the Balance 
Sheet in such manner as will show that this balance, 
taken in conjunction with the capital at commencement 
of the period covered by the Profit and Loss Account, 
and the drawings made since that date, represents the 
surplus of assets over liabilities. 

But it must be remembered that the surplus referred 
to cannot be a true surplus unless assets and liabilities 
are valued on a correct basis and that the record of 
gains and losses cannot be completed until all necessary 
adjustments in values have been made. 






^•j i 



•r 



PARTN ER S H IP ACCOUNTS. 



13 



These adjustments can only be made by reference to 
the Balance Sheet, and it is from the Balance Sheet 
that, in the case of a partnership, profits are to be 
ascertained. This method of ascertaining profits is 
known as the Single Account System. It is in theory, 
though not in practice, independent of any system of 
bookkeeping. 

An account taken as at the commencement of the 
trading operations of a partnership will disclose the 
amounts standing to the credit of each partner for 
capital contributed and a total of the assets correspond- 
ing thereto. 

Balance Sheet as at ist January 1912. 



Liabilities 

A. Capital 

B. „ 


£ s d 
2,000 
1,000 


A ssets 
Cash 

£ 


£ s d 
3,000 


£ 


3,000 


3,000 









In the course of trading the cash becomes invested in 
whole or part in the various assets incidental to the 
business. The partnership will, in addition, become 
liable in some amount to its creditors, and by means of 
this sum be able to hold assets to a correspondingly 
larger amount. 

The use of the assets produces profits, represented by 
a surplus of the assets over and above the liabilities, 
including Capital, as shown by the 

Balance Sheet as at 31st December 191 2. 



Liabilities 
Sundry Creditors 

A. Capital 

B. , 

Surplus 


£ s d 

1,800 

2,000 

1,000 

700 

! 


Assets 
Office Fittings and 
Fixtures.. . .jfioo 
Less Deprecia- 
tion . . . . 10 


£ s d 


- 


Stock-in-Trade 
Sundry Debtors £2,870 
Less Reserve 
for Bad Debts 250 


1,850 

2,620 
940 




Cash at bank and in hand . . 

£ 


£ 


5,500 


5,500 














H 



PARTNERSHIP ACCOUNTS. 







The profit made is represented by the surplus ^^700, 
and has been accurately arrived at from the Balance 
Sheet. 

It having been stated that bookkeeping by double 
entry shall be the system followed, the books in regard 
to the partnership of A. and B. would have been opened 
by entries on the debit side of the Cash Book : — 

£ s d 
2,000 o o 
1,000 o o 

which will be posted to the credit of the respective 
Capital Accounts. The Balance Sheet on p. 13 shows 
the position resulting, and the rights of A. and B. in the 
assets representing Capital are measured by the balances 
to their credit, and not by the proportions in which they 
share profits. 

The shares in profits being equal, the surplus of ;^7oo 
appearing in the Balance Sheet of 31st December 1912 
is divisible in equal shares between A. and B. This 
division will be accomplished by the following Journal 
entry : — 



Surplus (Profit and Loss Account) Dr. 

To Sundries 

A. Current Account 

B. 



(Being division of profit made during year ending 
31st December 1912) 




350 o o 
350 o o 



The analysis of gains and losses (called the Profit 
and Loss Account) resulting in the profit show n has not 
been set out, as being immaterial for present purposes, 
but is dealt with, as arising out of the bookkeeping 
device know^n as the Trial Balance, in Chapter IV. 



PARTNERSHIP ACCOUNTS. 



15 



It has already been decided that, according to the 
true construction of the Partnership Act, 1890, Capital 
and Profits are distinct funds, the former being as to 
the amounts agreed upon between the partners a fixed 
contribution, the latter a sum which the partners have 
the right to withdraw. 

For this reason, the profits have been passed, in the 
entry just given, to the credit of the partners* Current 
Accounts. 

This treatment would have been applicable also if 
there had been a trading loss, in respect of which losses 
an obligation would rest upon the partners to contribute 
such further amount {i.e., the amount of the loss charge- 
able to each) as would restore the Capital. 

The fact that this obligation is not as a rule operative 
in practice is no reason for ignoring its existence, for 
its non-operation will only become possible by express 
or implied agreement of the partners, and in certain 
circumstances it will be found to have a distinct bearing 
upon the rights of partners to the assets upon a dissolu- 
tion of the partnership. (See Chapter VIII.) 

As has been pointed out in Chapter I, there is 
nothing to prevent the partners from making fresh 
agreements as to the amounts of their respective contri- 
butions in respect of Capital, and, provided they all 
agree, they may do so — to the effect, for example, that 
as from 31st December 191 2 their Capitals shall be 
their original Capitals, plus profits; or, where any part 
of the profits has been withdrawn, plus undrawn profits. 
This fresh agreement will hold good until again varied, 



i6 



PARTNERSHIP ACCOUNTS. 



which may frequently be done, in the manner indicated, 
at any of the occasions of taking the accounts. 

Under such an arrangement, profits less drawings 
would be transferred to the Capital Accounts. A 
similar course would be adopted in regard to losses, 
if included in the arrangement. 

In opening the books of the partnership, each partner 
is to be credited upon his Capital Account with the 
agreed value of any assets contributed by him to the 
common fund, when such contributions are not in cash. 
For example, X., who is already in business, may 
arrange with Y. to carry on the business in partnership. 
The Capital contributed by X. would be the surplus 
of the assets over the liabilities of his business. In 
valuing that surplus, X. may demand that the value of 
the asset Goodwill, as already attaching to him, and in 
which Y. win in future be interested, shall be taken as 
part of his contribution to the firm. This may apply 
also where X. has no actual business, but has such 
connection and experience as represents a goodwill. 

In the example of opening entries which now follows, 
it has been assumed that X. is already in trade : — 



19x2 

Jan. I 



Sundries Dr. 

To Sundries — 

Office Furniture 

Horses, Carts, &c 

Stock-in-Trade 

Sundry Debtors 

Cash • 

Goodwill 

Reserve for Bad Debts 

Sundry Creditors 

X, Loan Account 

X, Capital Account 

(For agreed values of Assets, including 
Goodwill and Liabilities, taken over 
from X by the firm of X and Y) 




£ s d 



205 o 

3,895 o o 

2,850 o o 

5,000 o o 



f 



The Cash entries will be entered in the Cash Book. 



PARTNERSHIP ACCOUNTS. 



17 



Y. has, in effect, acquired a share in the profit or 
loss upon the asset Goodwill of the new firm, such 
share being dependent upon the proportions in which 
it has been agreed that profits and losses shall be 
divided. 

The treatment of Goodwill in Partnership Accounts 
is dealt with generally in Chapter V. 

An agreement for partnership may provide for equal 
shares in profits, although contributions of Capital are 
unequal. A., who finds twice as much Capital as B., 
may find compensation in the advantage of B.'s greater 
experience; B., with the balance of experience in his 
favour, is dependent on the use of A.*s Capital. 

In such cases many alternative methods of apportion- 
ing the profits may be adopted, with a view to rendering 
to the partners the share properly due to them. This 
is commonly done by apportioning the profit into— 
(i) Interest on Capital; 

(2) Services of management ; 

(3) Surplus earnings of Capital; 

in some or all of which the partners may be interested 
in agreed proportions. 

Arising out of the last paragraph, and also as a 
general direction, care must be taken that, in regard 
to all points affecting the accounts, the terms of the 
partnership agreement are observed, the presumption 
being in every case that any matter not determined by 
agreement is governed by the Partnership Act, 1890. 
The general consideration here given to the matter of 
the accounts has more detailed treatment in the succeed- 
ing chapters. 



CHAPTER III. 



THE BALANCE SHEET. 

The Balance Sheet must show the position of the firm 
in regard to the property of the partnership, as defined 
by Section 20 (i) of the Partnership Act, 1890 : — 

*• All property and rights and interest in property originally 
brought into the partnership stock or acquired, whether by pur- 
chase or otherwise, on account of the firm, or for the purposes 
and in the course of the partnership business, are called in this 
Act * partnership property,* and must be held and applied by the 
partners exclusively for the purposes of the partnership and in 
accordance with the partnership agreement. " 

From the consideration already given to the Single 
Account system of ascertaining profits, it is clear that 
the preparation of a correct Balance Sheet is not only 
essential to the correct ascertainment of the financial 
position, but also of profits. 

It is of importance, therefore, that the Balance Sheet 
should be not only full and complete, but accurate in 
regard to the values given to the assets and liabilities 
included therein. 

For the purpose of ascertaining the financial position 
of a firm, and, therefore, its profits. General Reserves, 
in the sense in which the term is used in connection with 
the accounts of limited companies, do not exist, except 
as forming part of the surplus of assets over and above 
liabilities to outside parties and liabilities to partners 



PARTNERSHIP ACCOUNTS. 



19 






upon Loan Accounts. Some part of this surplus may 
appear to the credit of a Reserve Fund, or Reserve, but 
is none the less part of the amounts due to the partners 
for Capital and/or Profits. The only Reserves permis- 
sible are such as are required to reduce assets to their 
true value or to make provision for accruing and 
contingent liabilities. 

The following example is of interest : — 

A firm of merchants trading with Mexico owned 
assets to a considerable value in that country. Some of 
these, in the form of buildings and plant, were subject 
to the risks of destruction by fire and earthquake. No 
policy of insurance on satisfactory terms being procur- 
able, the firm decided to create their own Insurance 
Fund. They therefore set aside each year such sums as 
in their opinion represented an adequate premium. The 
divisible profits were reduced accordingly, and the 
balance standing to the credit of the Insurance Fund 
was included in each Balance Sheet as a fair and reason- 
able reserve for the risks indicated. The reserve was, 
in fact, a provision against losses, not a general reserve, 
although it might in course of time partially represent 
the latter to the extent by which it came to exceed the 
amount fairly and reasonably necessary for the purpose 
for which it was intended. Such excess would be a 
profit, and properly transferable in each year from the 
Insurance Fund to Profit and Loss Account. 

The facts given are also considered in Chapter VI. in 
reference to a claim by the representatives of a partner 
to the deceased's share in the assets of his firm. 



c 2 



20 



PARTNERSHIP ACCOLNTS. 



It has already been decided, that in regard to assets 
held for permanent use, such as Plant and Machinery, 
the value to be regarded is not that of market value, as 
governed by supply and demand, but the value to the 
business as a going concern. 

In regard to the majority of assets held by a partner- 
ship, such as Land, Buildings, Plant, Book Debts, 
Cash, &c., some satisfactory evidence of value is 
generally available, based usually upon cost, or, in the 
case of Book Debts, upon definite contracts. The same 
will apply to the majority of liabilities, although with 
partnerships, as with any other form of association, 
estimates may in some cases have to be introduced in 
the absence of exact evidence. 

What has been said in regard to the valuations of 
assets applies equally to Stock-in-Trade, Work-in- 
Progress, Uncompleted Contracts, and the like; but, 
while the general principle that the asset must be fairly 
and reasonably valued is clear, considerable care has 
to be exercised in deciding what is fair and reasonable. 

In the case of a trading partnership, as practically 
the whole of the profit is derived from the margin 
between the selling value and the cost price of the goods 
sold, and as the margin is determined mainlv by a 
stocktaking valuation of goods iinsohi, the estimate of 
the asset Stock-in-Trade lias a very direct bearing upon 
the financial position and upon the profits. 

It is hardly within the limits of this work to consider 
in any detail the principles upon which Stock-in-Trade 
is to be valued, but it may be said that the basis of 



PARTNERSHIP ACCOINTS. 



21 



valuation is, in the first place, that agreed on by the 
partners. In the absence of definite agreement, it is to 
be presumed that the valuation will be such as may be 
considered a reasonable and true value as between all 
parties. It must be noted that a valuation once agreed 
upon may bind the partners in determining the amount 
due to a deceased partner's representatives as his share. 

In the case of Stock purchased for re-sale, no profit 
can ordinarily arise until sale. It is usually unwise, 
even where goods have been sold for future delivery, to 
estimate profits prior to actual delivery. The value of 
Stock unsold should not, therefore, be taken to exceed 
cost. 



On the other hand, full allowance should be made for 
deterioration below cost, especially where a loss upon 
actual sale is probable. 

Stock-in-Trade is, therefore, usually valued at the 
lower of two bases — cost or market value. There are, 
however, exceptions, in such cases as businesses dealing 
with seasonal crops of plantations (tea, coffee, rubber, 
&c.), or with the output of nitrate producing works and 
the like, where the custom is to give each year credit 
for the proceeds of the crop or output in that year, and 
to bring in Stock unsold at a valuation frequently 
equivalent to prices realised since the date of the Balance 
Sheet, less expenses of realisation. 

In regard to Work-in-Progress and Uncompleted 
Contracts, it may be stated generally that the endeavour 
should be to introduce such assets at such values as will 






PARTNERSHIP ACCOINTS. 






i 



apportion the profit over the periods in which it has 
been earned. 

There are, however, so many questions of fact 
involved as to render impossible the complete discussion 
of the points raised, and for further and fuller informa- 
tion reference should be made to a text-book dealing 
with the general principles of the theory and practice 
of accountancy. 

The valuation of Investments raises questions for con- 
sideration, particularly where held to further business 
connections, or as consideration for the sale and transfer 
of assets. 

In neither case, it is submitted, should they be valued 
above cost, while any loss should be allowed for. m 
the event of realisation the profit or loss is divisible in 
the agreed proportions. 

The following example is of interest : — 

Two partners, A. and B., carry on business as ship- 
owners. They control three main lines, running from 
Liverpool to South America, the States, and the East 
respectively. Having considerable funds invested in 
these groups of steamers, they determine, mainly for 
reasons of finance, to dispose of their interests to three 
separate companies, of which they act as managers and 
hold all the ordinary shares. The shares issued to them 
in each case amount to ;t'20o,ooo par value, but the 
book values of the assets transferred are (exclusive of 
Goodwill) only ;^ioo,ooo, ;^i20,ooo, and ;£'i50,ooo for 
each company respectively. 



PARTNERSHIP ACCOUNTS. 



23 



So far as the companies are concerned they will 
regard the differences as Goodwill, but the value so 
given to this asset may far exceed what the vendors 
could have obtained by a sale for cash. 

The introduction of the shares into the books at par 
will create a fictitious profit, which should not be credited 
to the partners, but held rather as a Capital Reserve 
until sale. To treat the profit as earned would cause 
an overstatement of either the Current or Capital 
Accounts. 

The illustration given must not be taken to affect the 
partners' freedom of contract. They may agree as they 
like as to values, but the illustration indicates the 
desirability of bringing in assets at fair values only. 
Elsewhere (Chapters IV and VI) the questions that 
might arise in regard to the facts stated in allowing for 
interest on Capital and in ascertaining the amount due 
to the representatives of a deceased partner are dealt 
with. 

As the correct estimation of assets and liabilities is 
a matter of much importance, it is desirable that the 
partners express their agreement to the values given. 

They can do this in regard to the asset of Stock by 
signing a certificate upon the Stock Sheets, or, in regard 
to the accounts as a whole, by signing the Balance 
Sheet as correct. 

Provision is frequently made in the articles of partner- 
ship that '* the accounts, when drawn up, shall be 
** signed, and shall thereafter be binding and conclusive 
*' upon all the partners, their heirs, executors, and 



24 



PARTNERSHIP ACCOUNTS. 



iC 



n 






assigns, save for manifest error discovered within 
** three months of the date of the submission of the 



** accounts.** 



Finally, as to the purpose of a Balance Sheet. It is 
primarily for the use and information of the partners 
themselves. They are ordinarily the judges as to the 
methods and principles adopted in its preparation. They 
may decide as to its publication or exhibition to any 
other party. 

No creditor has any right to see it, unless it is a term 
of some agreement made by him with the firm. A 
bank, for example, to which the firm is indebted, may 
require its production as a condition of continuing the 
facilities given, but no ordinary trade creditor has such 
a right. 

The production of the Balance Sheets may be rec|uired 
in connection with the firm's income-tax assessment. 
(See Chapter IX.) 



I 



«, 



f 



CHAPTER IV. 



THE PROFIT AND LOSS ACCOUNT. 



Ascertainment and Division 0¥ Profits 

AND Losses. 

The profits of a partnership have already been 
defined as '* the increase in the surplus of assets over 
liabilities." 

From the form of the definition and the consideration 
already given to the Single Account System of deter- 
mining profits, it is clear that the ascertainment of the 
increase in the surplus is dependent largely upon the 
preparation of an accurate Balance Sheet. Inasmuch 
as a Balance Sheet takes note of assets and liabilities 
as they are, and not of the gains accruing and losses 
incurred in the transactions by which the assets and 
liabilities are created, it makes no distinction between 
Revenue and Capital profits — the normal and the 
abnormal. 

This distinction is, of course, observed in the ordinary 
analysis of gains and profits given by the Profit and 
Loss Account, and partners, in their estimates of 
current progress, will naturally make allowance for such 
profits as cannot be considered to accrue in the ordinary 
and normal course of the partnership business. 

For the purposes of income-tax, again, a distinction 
will be drawn between Revenue and Capital Profits, but 



26 



PARTNERSHIP ACCOUNTS. 






this is a distinction based upon the interpretation of the 
Income Tax Acts and not of the Partnership Act. 

So far as the latter is concerned, Partners' Capital is 
looked upon as a fixed contribution. Anything appear- 
ing as the surplus of assets over liabilities, including 
liabilities to partners for sums previously contributed, 
is profit, however arising and whenever earned. 

In order, however, that a fair estimate of the profit 
earned since the date of the last Balance Sheet may be 
obtained, due allowance must be made for the balance 
shown therein upon Current Accounts (representing 
the balance of undrawn profits at that date) and for 
drawings made since the date of the last Balance Sheet. 

The presumption, in the absence of agreement, is that 
profits are divisible in equal shares, this being provided 
for by the Partnership Act, 1890; further, that, unless 
agreed for, no interest is to be credited to partners in 
respect of Capital contributions. 

The statement that profits are divisible equally does 
not determine that partners liave equal shares in the 
assets. Their shares in the assets of the partnership 
are fixed by the amounts appearing due to them upon 
Capital and Current Accounts, after making due allow- 
ance where necessary in respect of their contributions 
to\\ards losses. 

This has already been referred to, but as the matter 
may, perhaps, present difficulties to the student, the 
following Balance Sheets are submitted in explanation : 



v> 



•/ 



:\' 



PARTNERSHIP ACCOUNTS. 



27 



A.— Balance Sheet showing the position upon dissolu- 
tion prior to adjustment in respect of partners* contribu- 
tions for losses : — 



Liabilities 



£ s d 



A., Capital Account 
Current Accounts— 

Am • • • ■ • ■ 

*J. • • • • • • 



£200 
100 



Assets , jC s d 

r 
5,oo3 o o : Cash, after payment of 

1,000 c o Liabilities 5i40<' o ** 

Trading Loss 900 o o 



303 o o 



£ 6,30D o o 



£1 6,300 o o 



The partners share equally in profits, but B. is not 
entitled for that reason to one-half of the assets, ;{,'5,4oo. 

Nor is the cash to be allocated to A. and B. propor- 
tionately to the balances to their credit. Allowance 
must be made for the contributions due from them in 
respect of their respective shares of the trading loss of 
£goo. 



B. — Balance Sheet showing position after adjustment 
in respect of the contributions due by the partners 
towards losses : — 



4 



L iabilities 

A., Capital Account 
B., Capital Account 



£ s ci 



5,000 o 
1,000 o 



£: 6,000 o o 



Assets £ 

Cash 5,400 

A., Contribution for 

Share of Loss . . 450 
Less Current A/c 



Due from him . . 

B., Contribution for 
Share of Loss . . 
Less Current A/c . . 

Due from him . . 



200 



450 
100 



s 

o 



d 

o 



250 o o 



350 o o 
£ 6,000 o o 



28 



PARTNERSHIP ACCOINTS. 



1 1 



A.'s interest in the assets is ;^5,ooo, but towards the 
assets available for division he must contribute /'250, 
and his share on balance is therefore ;£'4,750. B/s 
claim is ;^650 (;6'i,ooo less ;6'35o). 

The division of the loss between tiie partners will be 
expressed according to the methods of double-entry 
bookkeeping by entries in the following form : — 



Dr. 



Sundries .. 

To Profit and Loss Account 

A., Current Account \ " 

B., Current Account [ 

(For transfer in equal shares of debit balance on Profit 
and Loss Account) 



£ s d £ s d 

900 o o 
450 o o 
450 o o 



The drawings will have been charged to the Current 
Accounts in the ordinary course. 

Equal shares in profits can only mean equal shares 
in assets, where Capital contributions, shares in profits 
and losses, and drawings have been equal throughout. 

The illustration given is in reference only to the point 
stated. The treatment of losses and deficiencies in 
general is the subject of further consideration. (See 
Chapters VI— V 11 1.) 

It has already been stated that there is need for every 
care in ascertaining correctly the financial position of 
the firm as regards the partners and the partnership 
liabilities, and that the correctness of the Balance Sheet 
is of further importance in its bearing upon profits. 

Profits must be ascertained as accurately as possible 
at every occasion of preparing the Balance Sheet. 
Failure to do so may affect materially the rights and 



t 



PARTNERSHIP ACCOUNTS. 



29 



interests of the partners in such profits, and, conse- 
quently, in assets. 

Where, for example, the division of profits follows 
certain proportions up to a stated figure, and above the 
figure stated certain other proportions, an error in 
principle in the preparation of the accounts may have 
material effect. 

Illustralion. — 

A. and B. are in partnership as solicitors. Up to the 
31st December 1908 they have shared profits equally. 
Their custom has been to ascertain profits by bringing 
into account bills of costs actually renderexJ, and by 
ignoring the value of costs earned on uncompleted 
matters. 

This practice hitherto has not adversely affected either 
partner. 

As from 31st December 1908, A. and B. agree that 
they shall share profits — 

(i) equally up to ;^40o; 

(2) thereafter, two-thirds to A., one-third to B. 

It is now of importance that the outstanding costs be 
brought into account, so as to give to each year the 
actual profit made. These outstanding costs are as 
follow : — 

31st December 1908 ;^26o o o 

1909 620 o o 

1910 860 o o 

1911 450 o o 

The contrast between the two methods of treatment 
is now shown in reference to the revised terms of the 
agreement. 



>» 



>i 



i> 



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ft 



30 



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> 

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o 






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< 



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at 



V 

^ ^ 



PARTNERSHIP ACCOUNTS. 




o\«^ 



S. 






•X O 



VJ 



N 



o 


o 




o 


o 




ci 


R 




«o 


oo 







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PARTNERSHIP ACCOUNTS. 



3» 






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32 



f 



PARTNERSHIP ACCOUNTS. 



-3 O 

i 


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1 


rxao <ri\o 







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u 

(9 »;£ 



^ C 

« in 

0) 3 

> n 



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PARTNERSHIP ACCOUNTS. 



33 



By way of further illustration of the general principles 
that underlie the preparation of Partnership Accounts^ 
the following example is of interest : — 

A firm of cotton merchants are creditors in the bank- 
ruptcy of X., a cotton spinner, for ;^2,ioo. They hold 
as security a policy on the life of the debtor for ;^3,ooo, 
and they prove in the bankruptcy, as partly secured 
creditors, for ;^2,ioo, less the surrender value of the 
policy ^420; net, ;^i,68o. 

For the purposes of their accounts, the partners make 
a Reserve for Bad Debts of ;^i,i76, being ^1,680, less 
an estimated dividend of 6s. in the £, This reserve is 
made in the year when the loss became known, and 
according to the best of the information possessed by 
the partners. 

The Trustee in Bankruptcy does not redeem the 
security and the bankruptcy is closed, a first and final 
dividend of 5s. in the £ being paid. 

The firm have, prior to the closing of the bankruptcy, 
paid one annual premium of ;^8o, and, after that date, 
determine to maintain the policy. They pay one further 
premium, when the debtor dies, and the policy moneys 
become payable. 

The accounts relative to the transactions referred to 
are as under : — 



34 



PARTNERSHIP ACCOUNTS. 






m o 



o o 


o 


I 

o 


o o 


o 


o 1 
1 


o o 
t« -I 


2 




, 


— 











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C 
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Q 

73 

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0Q 



1/1 "i: 



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IN <y *^ — 

oQ 4 



« « s; 



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-co c 

I/: O O 





«« 


o 


;j 








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o 


o 




^ 


5 


1-H 


c. j 


• 


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>1 


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o 
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K 

o 



8 



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•J5 O 



O 3 



, O S3 



o o 
o o 






o 
o 



X 



V 



u (J -1 



X 

o 



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ce ■ 



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Q 



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5 *» e 

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_.-c C-" 

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—IB • "" 

«(.',»» 

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o o o 
0.0. 



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PARTNERSHIP ACCOUNTS. 



35 



The endeavour in the foregoing example has been 
to give to each year its due share of profit or loss. 
This has meant an adjustment, for the purposes of each 
annual Balance Sheet, of the values of the assets and 
the allowance necessary as a provision for loss. 

Upon the facts of this illustration, the firm in respect 
of the transactions given made a loss in 1910 of ;{^ 1,176 
(estimated), a loss in 1911 of ;^74, and a profit in 1912 
of iJ2,4io. 

The provision for loss may be said to be normal, for 
bad debts are an ordinary result of trading. The profit 
in 191 2 is abnormal, for it can but seldom arise. Yet 
it is none the less profit, although it is abnormal. 

The illustration given has a further importance, for 
suppose there have been changes in the partnership, 
taking effect as at 31st December 1911. A. retires at 
that date, B. and C. continue. So far as A. is concerned, 
he has no right or interest in the profits of 191 2, in 
which B. and C. alone participate. These were not 
earned bv the firm of which he was a member. 

The matter is dealt with, together with other points, 
in Chapter VI, and is referred to here primarily to 
emphasise the importance of a correct valuation of assets 
and liabilities year by year, or at each occasion of 
taking the accounts. 

The illustration given may be considered in reference 
to the question of the annual reserves. It appears that, 
at the end of the year 1910, the Reserve for Bad Debts 
^in respect of the debt referred to) was calculated 'on the 

D 2 



36 



PARTNERSHIP ACCOUNTS. 



assumption of a dividend being received at the rate of 
6s. in the £, The dividend was actually 5s., and the 
shortage in the Reserve was made good the following 
year. The profits of the later year are therefore reduced 
by the amount of this extra charge. 

Where the profits of both years are received by the 
same parties, no substantial hardship could ensue. Any 
and every Balance Sheet must contain estimates. Where 
these are made by all the partners, or, what is equally 
valid, accepted by all the partners, as fair and reason- 
able, no one partner would ordinarily be able to 
question the accounts already drawn and accepted, 
unless thev adopted some vital error of principle, of 
which he had hitherto been unaware. Even in this 
latter case, the partnership agreement may hold him 
bound. 

It has already been stated that, in the limited company 
sense. Reserves do not exist, except where made as a 
provision for or indemnity against losses. Any surplus 
of assets over Capital, Parners' Loan Accounts, and 
amounts due to creditors, represents profits, and these, 
subject to any agreement made, may be withdrawn, for 
the Capital would still remain intact. Capital, however, 
can only be withdrawn by consent of all partners. 

From the examples given, it will appear that the 
correct ascertainment of profits year by year may affect 
considerably the financial interests of the partners, first, 
in their shares of profits; second, in the calculation of 
the amount (if any) due to them for interest on Capital. 



PARTNERSHIP ACCOUNTS, 



37 



The latter, however, can only be affected where accumu- 
lated profits are transferred periodically to the Capital 
Accounts or become entitled to interest by agreement. 

Difficult questions may arise for consideration in 
respect of the profit from appreciation of an asset held 
permanently by a firm and not acquired for resale. 

An example has already been given (see last chapter) 
of the effect upon the accounts of a sale of assets for 
shares of greater par value than that of the assets 
transferred. 

The introduction of the shares into the books of the 
partnership at par obviously created a fictitious profit, 
and the accounts of the partners consequently over- 
represented the values of their interests. 

Had the fictitious profit been transferred in the 
balance of the Current Accounts to the Capital 
Accounts, the latter would also have been overstated, 
and the amount (if any) credited for interest upon 
Capital would have been calculated upon an incorrect 
figure. While the shares in profits continue the same, 
this may not greatly matter, for both (or all) partners 
would bear the additional charge for interest in exactly 
those proportions in which it has been credited to their 
accounts; but, upon any change in the proportions, 
difficulties will arise. 

The case, however, may not be so clear on the facts 
as that just referred to. The asset in question may 
originally have been worth less than par, but may 
gradually have appreciated, until par represents its 



38 



PARTNERSHIP ACCOUNTS. 



PARTNERSHIP ACCOUNTS. 



39 



realisable value, or, possibly, even less than its realis- 
able value. 

In all such cases, it is submitted that, both as a matter 
of convenience and of correct treatment, no profit should 
be assumed for the purposes of the annual accounts until 
the asset has actuallv been realised. No unrealised profit 
can be divided, and upon assets of the class stated none 
should be anticipated, but this must be taken as applying 
to the annual accounts only, and not as applying to the 
ascertainment of the amount due to a retiring partner 
upon dissolution, or to an agreed revaluation upon a 
change in the proportions in which profits or losses 
are to be divided. 

Some assets are unrecorded. The most prominent 
example is that of Goodwill, but there may be others. 
These may have been written off entirely in the books 
of account while still possessing value, or may be 
unrecorded through having arisen from no definite 
transaction involving the transfer of money or money's 
worth. 

A firm, for instance, holds shares in a company as an 
investment. The company is wound up. The liquidator 
repays the whole of the Subscribed Capital in full, and 
in addition distributes further shares in a subsidiary 
companv. The original Investment Account is closed, 
and, following the principles stated, no profit would be 
anticipated on the new shares received. They would 
be recorded as a memorandum only, or they might be 
divided among the partners in specie. 

The reasons for ignoring Goodwill in the annua! 
accounts, where not purchased, but created by the 



t 

I 



energy and skill of the partners in the development of 
their business, are : — 

First, that the asset has a fluctuating value which is 

dependent upon the maintenance of the firm's 

connection and reputation. 

Second, that the value of the asset cannot be definitely 
measured until sale. 

Third, that the value is unrea lised. 

But, although unrecorded, the asset must nevertheless 
be brought into account upon a dissolution. 

In regard to assets other than Goodwill, the partners 
are perfectly free to reduce values below their true value 
if they think fit. This, however, is a departure from 
general principles, which would not ordinarily be 
adhered to in determining a partner's share upon 
dissolution. 

The division of profits between the partners will 
follow the terms of the agreement made, and will, in 
the absence of agreement, be made in equal shares. 

But, where Capitals are unequal, the partners may 
agree that allowance shall first be made for interest on 
Capital; or, where the values of the services rendered 
by the partners are unequal, that allowance shall be 
made for partners' salaries prior to arriving at the net 
profit available for distribution. 

These allowances, which are only to be made where 
expressly agreed for, are plainly designed to compensate 
partners for the particular benefits conferred upon the 
partnership by them individually. 



40 



PARTNERSHIP ACCOUNTS. 



« 



ig 



The allowance for interest (it has been stated) is a 
matter for agreement. Agreement may be express, or 
merely implied. An entry in the books crediting the 
partners with interest might — and where made with the 
approval of the partners, would — be sufficient evidence. 
But all the facts must be looked at. 

The allowance for salary may be to one or to all the 
partners. 

The partners in the various local branches of a large 
business may each take a salary from, plus a share of 
the profits of, the respective branches under their control, 
the surplus from each being pooled and divided in 
accordance with the partnership agreement. 

A. and B., who are partners, may agree that A., who 
has had the greater experience, be credited with a 
salary, and that B., who has found all the Capital, be 
credited with interest, prior to the division of any 
balance remaining in equal, or other agreed, shares. 

A partner may, by agreement, receive a salary for 
special services, the balance of profits being divided as 
previously. This may be for one year only, or be a 
permanent arrangement, continuing throughout the 
term of the partnership, or until further agreement. 

The charges for interest on partners' Capital and for 
partners' salaries rank equally, as between themselves, 
and are ordinarily borne by all the partners in the 
proportions in which they share surplus profits. 



PARTNERSHIP ACCOUNTS. 



41 



i 



I 



This is so because (i) the balance remaining for 
distribution after these charges have been made is 
reduced pro tanto, and (2) such charges must be made 
against the Profit and Loss Account, even if the effect 
of them is to create a "loss" or to increase the loss 
incurred before such charges are made. 

Partners might agree, however, that one partner 
should receive a salary, or interest, or even a share in 
or an extra proportion of profits, solely out of another 
partner's share. 

For example, A. and B. are equal partners. B. w ishes 
to retire from active management (while still continuing 
a partner) and to introduce C. A. is unwilling, but 
finally agrees, on the understanding that C.'s salary 
as a partner (;^*40o) and share of profits, one-sixth, is 
chargeable to B., except as to the salary (;^30o) w^hich 
C. has formerly had as manager. 

The following accounts are given in illustration : — 

A. — Apportionment of profits in ordinary simple case, 
allowing for interest on Capital and partners' 



salaries. 



Dr. 



Profit and Loss Account. 



Cr. 



To Interest on Capital : 

A /J400 

B 200 


£ s d ' 

1 
600 

750 
745 
745 j 


By Balance 


2,840 


, Salaries : 

A j(,"5oo 

B 250 




» A., one half-share of balance 
H B., do. do. 




£ 


2,840 n 


2,840 









h I 



4^ 



PARTNERSHIP ACCOUNTS. 



B.— 



Dr. 



Allowance for a partner's (C.'s) share in profits 
and part salary (;{;ioo) out of the share of another 
partner. 

Profit and Loss Account. 



Cr. 



Tc Interest on Capital : 

■^ £3bo o o 

tJ- . . . . 420 o o 



Salaries : 
A. 
B. 
C. . 



. . 5^480 o o 
. . 360 o o 
. . 400 o o 



• A., one half-share of Profits, 

£1,560 plus A.'s saiat)' 
,, £100— £1,660 
«, B.. one half- share 

of Profits £830 o o 

Less C., part 
salary .. £ico 
Share in 
Profits :— 
£1,560, one 
sixth . . 260 

360 o o 

• C . , one-sixth share ol Profits 



if s d 



800 o o 



1,240 o o 



830 o o 



By Balance 



£ s d 
3,600 o o 



470 00;: 
260 O o 



£ 3,600 o o 



£ 3600 o o 



C— 



Simple case, similar to case (A.), but where profits 
are insufficient to cover interest and salaries. 



Dr. 



Profit and Loss Account. 



Cr. 



To Interest on Capital : 
A. , . . . £6ci» 
B 3C0 











£ 

tjOO 

900 


s 






d 






By Balance 

, A., one half of Debit 

Balance 

» B., one half of Debit 

Balance 

£ 


£ s 
1 1,200 

300 

300 


d 






• Salaries : 

A £400 

B 500 

















i 






1,800 





• 


1,800 
















PARTNERSHIP ACCOUNTS. 



43 



q 



D. — Illustration, following on case B, where profits 
are insufficient to cover interest on Capital and 
partners' salaries. 



Dr. 



Profit and Loss Accoi xt. 



Cr. 



To Interest on Capital : 

A £380 o o 

B. . . . . 420 o o 



£ s d 



„ Salaiies: 
A. 

B. . 

C. . 



£480 o u 
360 o o 
400 o o 



800 o o 



1,240 o o 



By Balance 

„ A., one half-share of 
Debit Balance, £1,440, 
less part of C.'s salary, 
£ioo=£i,340 .. 

„ B., one half- 
share of 
£1,340 ..£670 o o 
Add C, part 

salary . . 100 o o 

770 o o 
Less C , one- 
sixth share 
of loss £1,440 24c o o 



£ 
600 



d 

o 



670 o o 



*£ 2,040 o o 



C, one -sixth share of 
£1.440 



530 o 
240 o 



£ 2,040 o o 



The illustrations B and D suggest the importance of 
reducing the arrangement regarding the partner C. to 
exact terms admitting of no doubt. 

It will be observed that the profits, of which A. 
receives one-half, represent the balance as it would be 
if charged with C.'s salary as ^'300 only, while for C. 
the division is upon the basis of his real salary of ;^400. 

So far as the particulars are given (cases B and D), 
nothing is said as to C.'s share in losses. 

It will, in the absence of agreement, be presumed that 
losses are borne in similar ratios to the interests of the 
partners in profits. As B. has in good times parted with 
a share of his profit, so in bad times he is entitled to be 
relieved by C. of a portion of his loss. C. is thus (in 



AA 
"IT 



PARTNERSHIP ACCOUNTS. 



PARTNERSHIP ACCOUNTS. 



45 






I 



the last illustration) credited with ;6400 by way of salary 
and debited with £2^0 share of loss. 

From the illustrations A and C, it appears that the 
salaries of partners and interest on Capital are to be 
allowed whether profits are sufficient to cover them or 
not, and that they are in effect borne by the partners as 
a whole in the proportions in which they share profits. 

As interest and salaries are prior charges, partners 
receive direct and immediate benefit in the whole of the 
amount of these prior charges due to them, but bear 
a proportionate part only of such charges. This may 
operate to benefit a partner considerably. 

Illustration, — 
^''- Profit and Loss Accouxt. Cr. 



To Balance 

„ Interest on Capital— 

A £ioo 

^ 120 



• A., Salary 





S 


(I 


200 








220 





1 



500 








£ 92 i 







1 



By A., One-half Share of 

Debit Balance 
„ B., One-half Share of 
Debit Balance 



£ s d 

460 o o 
460 o 



£92 D J O 



A., through having salary and interest credited to him 
as a prior charge, has actually been allowed ^:6oo, and 
been charged with ^'460 only, being his share of the 
uhimate debit balance. Thus, although the trading has 
resulted in a loss of £200, A. is credited on balance with 
;6'i4(), while B. is charged on balance with ;^340. 

The allowance for Interest on Capital will be 
calculated as may be agreed, but where mere agreement 
exists without any precise indication, it will be calcu- 
lated upon the amount standing to the credit of the 



partners upon their Capital Accounts as and when last 
agreed, and upon any additional contributions since 
that date as from the respective dates when made. 
Consequently, no charge will be made, unless this is 
clearly part of the agreement, for interest on periodical 
drawings. 

Drawings are made by consent. The partners can 
regulate the amount thereof by agreement. They are, 
as a rule, deemed to be on account of current or accumu- 
lated profits, and not of Capital. 

Drawings may take place during bad times. They 
are then either withdrawals of accumulated past profits, 
or of Capital, the latter being in effect a reduction of 
the Capital contributions of the partners. Even in the 
latter case, no interest will be charged, unless very 
clearly and definitely provided for; but when the 
accounts are made up at the end of the usual period, 
and the loss is actually ascertained, the drawings must 
be repaid to the partnership or be agreed on as being 
a reduction of Capital to that extent. 

With a view to avoiding any inequality, it is desirable 
to provide that the drawings of partners be made at 
regular dates and proportionately to the interest of the 
partners in profits and losses. 

Interest on Capital must be distinguished from 
Interest on Advances made by partners. Capital does 
not carry interest unless agreed, but advances carry 
interest independently of agreement, the rate being fixed 
at 5 per cent, per annum by the Partnership Act, if no 



46 



PARTNERSHIP ACCOUNTS. 



Other rate has been agreed. It has been pointed out 
in Chapter I that, partly for this reason, some care is 
necessarv in forming a conclusion whether amounts paid 
in by a partner are a further contribution on account of 
Capital, or distinct advances. This is a question of 
fact, but where specific amounts have been named in 
the partnership deed as being the Capital contributions, 
any further advances are prima facie loans in the nature 
of advances. 



The balances standing to the credit of partners on their 
Current Accounts are not to be treated as Advances or 
Loans to the partnership, unless so agreed by the 
partners, and, in the absence of such agreement, no 
interest should be allowed thereon. 

A provision is occasionally found in articles of 
partnership to the effect that profits and losses are to 
be borne by the partners in the proportions in which 
they have contributed Capital. The correct ascertain- 
ment of these contributions is then of special importance. 



It will usually be found to be the case that partners 
in such circumstances have had in their minds some 
ratio for the division of profits more or less approximate 
to the proportions of the original Capitals. 



It is quite conceivable that a partner may have a 
balance to his credit on Capital Account, while indebted 
to a larger amount on Current Account. A. and B. 
(for example) are partners ; they contribute as their 
Capitals — A., ;£'5,ooo; B., ;t'i,ooo; and agree to divide 



PARTNERSHIP ACCC^UNTS. 



47 



profits and losses in the proportions of these amounts, 
subject to allowance for : — 

1. Partners* salaries — A., /!^40o; B., nil. 

2. Interest on Capital at 5 per cent. 

The following is the Balance Sheet as at 31st 
December 1910 : — 



Liabilities 

Sundry Creditors 

A. Current Account .. 

A. Capital Account . . 

B. Do. .... 


/: 

12,400 

3,400 

5,000 

1,000 


s 







d 












£21,800 









A ssets 

Sundry Debtors . . 

Stock 

Balance at Bank . . 

Cash in Hand 

B., Current .Account 



s d 



".440 


u 





8,290 








1,450 








100 








600 








£21,^.80 










IMMi 


■■■■»■ 



B. does not pay in the ;i'6oo required to restore his 
Capital, but A. agrees that it shall be allowed to remain 
outstanding at 5 per cent, interest, provided that he (A.) 
is credited at a similar rate in respect of the balance 
to his credit upon Current Account. 

The year 191 1 results in a loss : — 



Dr. 



Profit and Loss Account, i()ii, 



To Balance 

„ A. , Current .Account-Salary 
„ Current Accounts, for 
Interest on Capital, &c. 

A. 420 o o 

B. 20 o o 



£ s d 

2,800 o o 
4C0 o o 



440 o 

£■3,640 



By A., five-sixths share of 
debit balance . . 

By B., one-sixth share of 
debit balance .. ,. 



Cr. 



£ s d 

3.033 6 8 

606 13 4 



£"3,640 o o 



B.ALANCE Sheet as at 31st December igii 



I 
Liahihties. 

£ s d 

Sundry Creditors 10,482 o o 

A. Current Account .. ..1 1,18613 4 

A, Capital Account . . . . I 5,000 o o 

B. Do. I 1,000 o o 



/ 17,668 13 4 



As:ets. 

Sundry Debtors 

Stock 

Balance at Bank 
Cash in han<l . . 
B., Current Account 



10,382 o 

6,010 o 

65 o 

25 o 

1,186 13 



d 

o 
o 
o 
o 
4 



£1 17,668 13 4 



48 



PARTNERSHIP ACCOUNTS. 



PARTNERSHIP ACCOUNTS. 



49 



The proportions for division of profits will continue 
until some fresh agreement is made. This may seem 
unfair while B. is indebted to the firm for so large a 
sum, but the choice of the proportions for sharing 
profits as the same as those of the original Capital 
might simply have been expressed : A., five-sixths ; B. 
one-sixth; and the connection with shares in Capital 
would disappear. 

A correspondent to The Accountant (23rd November 
1907) raised the question of the interpretation of the 
following clause in a partnership agreement : — 

"If any partner shall lend money to the partnership firm, 
other than his original share of capital, the firm shall pay such 
partner on such sum a due proportion of the net profits calculated 
according to share of capital, the first payment to become payable 
immediately after the next stocktaking." 

If the further advances are to be distinct from 
the original Capital, as the words " shall lend '* 
would imply, the ** due proportion *' should properly 
be calculated according to " share of capital plus loans." 
Interpreted in this sense, the clause merely determines 
the rate of interest to be paid on advances. It provides 
that there is to be no interest unless there are profits, 
and that the rate of interest (if any) payable is to be 
determined by the ratio of profits to Capital plus 
Advances. 

Where advances have been made at various dates 
during the period, it will be necessary to arrive at 
an average due date in order that the ratio might be 
calculated, for in this wav the sums advanced are 



brought into account at the computed equivalent for 
the full period. 

That part of the profits which is determined as being 
interest would then be reserved from the division of 
profits, the balance being divisible as agreed. 

Illustration. — 

A. and B. are in partnership. The profits for the 
year 191 2 are ;6i>500, subject to interest on advances 
under the clause given, and divisible as to the balance 
equally. 



A.'s Capital is 
B.'s Capital is 



/;4,'ooo 

;^2,000 



A. has advanced during the year : — 

March 31 ;^6oo 

July 31 ... 

September 30 ... 



200 
200 



;^I,000 



The first step is to arrive at an average due date : 



March 31 
July 31 ... 
September 30 



No. of days 
Amount from beginning 
of year 

£ 

600 



200 
200 



90 day-s ... 
212 „ ... 
273 >» 



;^I,000 



£ 

.. 54,000 

42,400 
.. 54,600 

;^I5I,000 



The average due date is : — 

151,000 divided by 1,000=151 days from beginning 
of year = 31st May. 

A. is entitled to interest on ;^i,ooo from 31st May 
to 31st December = 214 days. 



so 



PARTNERSHIP ACCOUNTS. 



PARTXEH SHIP ACCOUNTS. 



51 



The profit is divisible as follows : — 

Capital ...\ 6,000 for 365 days = 2,190,000 for i day. 
Advances ... 1,000 ,, 214 „ = 214,000 „ „ 



/7,ooo 



/2, 404 ,000 



The interest consequently is ^^-^^ of ;^i,50o= 

« 

;^i33 los. 6d. 

The amount of ;6 1,500 is therefore divisible as 
under : — 

Profit. Interest. 

;^ 3 d ^ S d 

A. one-half of ;^i,366 9s. 6d. ... jC^S^ 4 g and 133 10 6=816 15 3 

B. do. do. ... 683 4 9 =6&3 4 9 



;^I,500 o o 



An example of the method of preparation of a Profit 
and Loss Account and Balance Sheet from a Trial 
Balance of partnership books is now given. 



Trial Balance, 31st December 1912. 

£ 

Finished Stock on hand 31st December 191 1 7,570 
Raw Materials on hand 31st December 191 1 3,630 
Purchases — 

Raw Materials (less returns) 30,380 

Chemicals (less returns) 1,560 

Sales (less returns) 

Wages 12,420 

Rates and Taxes ... 860 

Salaries of Works Managers and Super- 
intendents ... ... ... ... ... 1,210 

Discounts allowed ^ 1,120 

do. received 

Advertising 3>350 

Carriage Inwards 1,140 

do. Outwards 849 

•Office Expenses 4,75o 

Bank Interest 

Patent Rights 840 

Royalties 130 

Land and Buildings 6,000 

Plant and Machinery 1,200 

Sundry Debtors ... ... ... ... ... 28,400 

Sundry Creditors 

A., Capital Account 

A., Current Account (;^3,8oo, less drawings) 

A., Loan Account 

B., Capital Account 

B., Current Account (;^2,32o, less drawings) 

B., Loan Account 

■Cash in hand ... ... ... .>• ... 7^ 

Balance at Bank ... ... ... 1,420 

Bad Debts ... ... ... ... ... ... 350 

Reserve for Discounts ... 

Jieserve for Bad Debts ... ... 



Cr. 



64,600 



506 



>s 



16,920 
8,000 

2,590 
6,000 

4,000 

918 

2,000 



1,080 
620 



;^io7,249 ;^io7,249 



E 2 



r 



52 



PARTNERSHIP ACCOUNTS. 



PARTNERSHIP ACCOUNTS. 



53 



The preparation of the usual accounts and Balance 
Sheet is required. 



The Stock on hand at 31st December 1912 is valued 
at : — 

••• ••• ••• ••• ... ji.^^2.20 



Raw Materials ... 



Finished (ioods. 



• • • ■ • • 



9420 



The follow ing^ allowances are to be made : — 



Depreciation on Buildings (;^4,ooo) 

do. Plant 

do. Patents 

Reserve for liad Debts to be brought up to ... 
do. Discounts do. 

Outstanding Rates 

do. Royalties 



... 10 o^ 

i/i4th 

- 5 % 

- 5 % 

;^l60 
^60 



Rates, etc., are to be taken as attributable to the 
extent of two-thirds to Manufacturing Account. 

The partnership agreement provides as follows: — 

Salaries— A. ^400 

B. ... ... ... /'300 

Interest on Capital at 5 per cent, per annum. 
Balance profits, to A. two-thirds, B. one-third. 



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PARTNERSHIP ACCOUNTS. 



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PARTNERSHIP ACCOUNTS. 



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56 



PARTNERSHIP ACCOUNTS. 



PARTNERSHIP ACCOUNTS, 



57 



I 



From a superficial examination of the Balance Sheet 
it is evident that the amount of the partners' Capital 
is inadequate for the needs of the business. 

An adjustment is therefore made, taking effect as 
from the date of the accounts. The new terms agreed 
are : — 



I. 



The Capital to be increased to ;t'20,ooo, to be 
divided— as to A., ;^i 2,000; B., ;6'8,ooo; this to 
be accomphshed by transfer from f.oan and/or 
Current Accounts. 

2. The Loan and Current Accounts, as adjusted, to 

be credited with interest at 5 per cent, per annum, 

3. Profits to be divided as follows : — 

Salaries— A /: 1,000 

^^- ;£^8oo 

Interest on Capital at 5 per cent, per annum. 
Balance to A., three-fifths; and to 
B., two-fifths. 

The following Journal entries become necessary : — 

A. Loan Account Or. /:4,ooo 

To A. Capital Account 

For transfer from former account of increase 
in Capital contribution due from A. 

Sundries ^^ 

To B. Capital Account 

B. Loan Account 

'•• "•• ••• «,« 

B. Current Account 

For transfer from Loan and Current 
Accounts of increase in Capital contribu. 
tion due from B. 



;^4'Coo 



4,000 



2,000 
2,000 



It may be necessary in some cases to arrive at a 
statement of the financial position and profits of a firm 
from incomplete accounts. 
Illustration. — 

A. and B. commence trading in partnership on 1st 
Januarv 1909. They contribute Capital at that date as 

under : — 

A /:2,ooo 

^ B i,'i,ooo 

Their books are kept by single entry. 

Their drawings have been : — 

A /^3 per ^veek. 

B £20 per month. 

The profits, subject to interest at 5 per cent, on the 
original Capitals, are divisible equally. 

In February 1913 instructions are given for the 
preparation of a Bak\nce Sheet as at ^^^^t December 
191 2, and a statement of the profit made up lo that date. 

The Balance Sheet is submitted in due course. It 
discloses a surplus of assets (specified) over liabilities 
other than Capital (specified) of /'2,850. 

l}r. Statement of Profit. Cr. 



1909 

Jan. 1 


To Capital :- 
A .. 
B .. 


• • 


2,000 
1,000 


£ 
3.000 


1912 
Dec. 31 


» 


Interest 
Capital 
A .. 
B .. 


on 

• • 

• • 


400 
200 


600 




H 


Profit :- 
A .. 
B .. 


• • 


417 
417 


834 




£4,434 







I9I2 
Dec. 31 



By Surplus of .\ssefs 

over Liabilities 

(as specified) . . 

. Drawings since 

1st January igog 

A . . 624 

B ..960 



2,850 
1,584 



£4,434 



til. 



58 



PARTNERSHIP ACCOl NTS. 



The Balance Sheet as at 31st December 1912 would 
be rendered complete by the inclusion of the Current 
Accounts, as under: — 

A. Current Account — 



Interest on Capital 
Share of Profit 



Less Drawings 

B. Current xVccount. 

Drawings 

Less Interest on Capital 
Share of Profit ... 



;^200 

417 



/400 
417 

817 
624 



960 



6,7 



£^9Z Cr. 



£3A3 L>r. 



The following illustration shows the adjustment where 
interest is allowed on the Capital as at the commence- 
ment of each year. 

\. and R. commenced trading in partnership on ist 
January 1909. Their Capitals at that date were— A., 
^.4,000; B., ^'2,000. B. agrees to purchase a one-half 
share in the goodwill of A.'s connection at the price of 
;(:8oo, to be paid for out of B.'s surplus on Current 
Account, as appearing at the end of each year. A. 
agrees not to withdraw the sums so paid, but to regard 
them as additional Capital. B. is limited in his drawings 
to ;^:4oo per annum until the sum of ^800 mentioned 
has been paid. Profits are divisible, subject to 5 per 
cent, interest on Capital, equally. 

It is desired to ascertain the position of the partners 
as at 31st December 191 2. 



PARTNERSHIP ACCOUNTS. 



59 



The preparation of Balance Sheets at the end of each 
year discloses surpluses as under : — 

31st December 1909 

1910 
1911 
1912 



>> 



>» 



»» 



;^6,220 

6,495 
7,086 

7»732 



A.'s drawings have been in the years stated £a^, 
;^47o, ;^520, and ;^500 respectively. 



6o 



PARTNERSHIP ACCOUNTS. 






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PARTNERSHIP ACCOUNTS. 



63 



CHAPTER V. 



TREATMENT OF GOODWILL IN PARTNERSHIP 

ACCOUNTS. 



The matter already set out has to a large extent 
covered the portion of the subject relating to the 
admission of a partner. Thus, in Chapter II, the 
opening entries relative to a new firm were given. It 
was there shown how Capital contributions were to be 
treated and how such contributions might not neces- 
sarily be made in cash, but be represented by the surplus 
of assets, less liabilities, brought in, as where an 
individual amalgamates his business with that of 
a firm. 

The treatment given to the entries referred to is 
precisely applicable to the case of the admission of a 
partner to an existing firm. 

To the new firm so formed an incoming partner will 
contribute Capital, which will be duly credited to his 
Capital Account, and will thereafter represent his share 
or interest in the assets in respect of Capital. The 
distinction between this case and that referred to in 
Chapter II is, that in the former there already exists a 
firm, the members of which have contributed Capital, 
and in the latter all parties bring their contributions at 
the same time to the common fund. 



The common fund is the ** partnership property." 
In that fund the members of the partnership have rights 
measured originally by their contributions to it. In 
course of time, their rights will be affected by the 
operations in regard to that fund. 

Thus, A. is admitted as a partner into the firm of 
X., Y. & Co. He agrees to contribute as his Capital 
;^2,ooo, and in part consideration thereof is allowed a 
one-quarter share in profits. 

A.'s original interest in the partnership property in 
respect of Capital is ^'2,000, as will, appear from the 
books, A. having been credited with that amount. His 
interest in profits will arise in the future; it will be 
dependent upon the improvement in the surplus of 
assets over liabilities. From the time of his entry into 
the firm, A. is interested in all profits arising, unless 
some particular form of gain {e.g., upon a particular 
asset) is reserved b\' express agreement to the other 
partners. 

He will usually be entitled to claim as profit any 
amount realised upon an asset over and above book value. 
The asset may not have a book value ; it may, in fact, be 
unrecorded. The whole gain would then accrue to those 
who were partners at the time of its realisation, unless 
there is clear evidence to show that this basis of division 
was not agreed upon. 

In order that this may be understood, some considera- 
tion is necessary of the position created by a change in 
a partnership from death or retirement of a partner, 



11 



♦ 






64 



PARTNERSHIP ACCOUNTS. 



on the one hand, or the admission of a new partner, 
on the other. 

It is essential to reahse that, upon any of these events 
occurring, there is formed a new partnership. The 
former i^artnership has ceased to exist, the new one 
takes its place. It may do so by continuing the trade 
name of the firm, by carrying on its business, by a 
complete succession, in fact; but it is a new firm or 
association of individuals, though not recognised in 
English law as an entity distinct from the partners 
composing it. 

The new or continuing group of partners acquires 
or succeeds to the full interest of the former partnership 
in the property of the firm. 

This position, which is of much importance in regard 
to the accounts, is often obscured by the fact that 
it is seldom that a general change in the personnel of 
a firm occurs. There are usually certain partners con- 
tinuing. They may add others to their number, but 
they preserve a continuity in the management of the 
firm's affairs and possibly in the firm name also. 

The books of account are frequently, and, in fact, 
usually, continued, being adjusted only to show the 
amount due to a retiring partner or a deceased partner's 
representatives or the interest of an incoming partner, 
but not so as to show throughout the books in general 
the full effect of all adjustments and revaluations made 
in arriving at the desired resuh. 



PARTNERSHIP ACCOUNTS. 



65 



When a partner enters a firm he is ordinarily entitled 
to hold the other partners bound to the values given to 
assets and liabilities at the date of his admission. 

In continuation of the illustration, let it be assumed 
that the Balance Sheet of the firm of X., Y. & Co. 
(referred to) immediately after the admission of A. (ist 
January 191 2) is as follows: — 



Liabilities 

Sundry Creditors 

Capital Accounts — 

A. (*) . . . . £lO,C*)0 

Y. (I) . . . . 4.000 

A. (|) .. .. ^,000 



I d 



Assets 



» d 



8,000 o o j Plant and Machinery . . ; 4.000 o o 

I Stock \ 6,200 o o 

I Debtors 10,300 o o 

j Cash i 3,300 o o 

16,000 00! 



24,000 O O I 



/ 34,000 o o 



The asset of Goodwill is unrecorded in the books. 

On 30th June 191 2 a dissolution takes place, the assets 
are realised in due course, and the Goodwill is sold for 
;£'2,400. A. claims this as a profit, in which he is 
interested. X. and Y. contend that A. has paid nothing 
for his interest in the asset, and that therefore the gain 
accrues to them only. 

• 

X. and Y. were perfectly competent to make an agree- 
ment with A., upon his admission as a partner, to the 
effect that A. should have no interest in Goodwill, but 
they did not do so. They admitted A. as a partner upon 
terms which did not exclude the ordinary interpretation 
of the position that A. became interested in any gains 
arising. It is no answer to say that A. paid nothing 
for his share in the Goodwill, for he paid nothing 
specifically for any asset; he was given an interest in 



I 



n 



66 



PARTNERSHIP ACCOUNTS. 



profits and losses in return for his Capital and (presum- 
ably) his services. A. may have considered Goodwill 
to have some value, but he may have thought other 
assets to be overstated. The contract must be looked 
at as a whole. 

The example last given serves to emphasise the 
importance of making such adjustments prior to the 
admission of A. as will make the Balance Sheet of the 
firm show assets and liabilities at proper figures. Thus, 
the Balance Sheet prior to the admission of A. might 
have been revised in respect of the values of the items 
stated therein and be presumed to appear after adjust- 
ment as under : — 

Balance Sheet, ist January 1912. 



Liabilities 

Sundry Creditors 
Current Accounts — 

X. (|) 

Y. (|) 

Capital Accounts 
X.(i) .. .. 
Y.(i) .. .. 



£467 
233 

• • • • 

£10,000 
4,oco 



£ sd 

8,000 o o 

700 o o 

14,000 o o 



£\ 22,700 o o 



A ssits 



1,800 o 



3,400 o 



Goodwill 

Plant and Machinery 
Stock . . . . ' 6,000 o 

Debtors.. .. £10,300 
Less Reserve for 
Bad Debts . . 300 

10,000 o 

Cash , 1,500 o 



o 

o 



o 
o 



£ 22,700 o o 



A. then enters the firm upon the position as shown by 
the revised Balance Sheet. He contributes Capital as 
before, and is affected by gains and losses as may be 
agreed, but the gain in respect of Goodwill is now only 
X600 and not ;^2,400. 

The example given may lead conveniently to a con- 
sideration of the treatment of Goodwill in accounts. 



PARTNERSHIP ACCOUNTS. 



67 



In ordinary circumstances, as, for instance, between 
X. and Y., when there was no question of A.*s admis- 
sion as a partner, there would be no reason for keeping 
any balance open upon Goodwill Account, and it is 
commonly treated as an unrecorded asset. But in the 
special circumstances of the admission of a partner it 
becomes desirable to value it, which is accordingly done. 
Assuming no other asset account to require adjustment, 
the following Journal entry becomes necessary :— 

f>r. ;^i,8oo 



Goodwill Account 

To Sundries. 

X. Capital Account (i/ards) 
Y. do. (i/ard) 

For shares in this asset now introduced 
into the books. 



;^I,200 

600 



Upon A.'s admission, the Balance Sheet is affected in 
that he appears in credit upon his Capital Account for 
£2,000, and the cash is increased by a like amount. 

In the partnership of X., Y. & A., Goodwill can once 
more be treated as an unrecorded asset and written back 
to the Capital Accounts in the new proportions— viz., 
shares of profits not of Capital— for it is in these pro- 
portions that the partners will share in any subsequent 
gains, including that arising upon the realisation of 
Goodw^ill. 

The following Journal entry can therefore be made : — 



Sundries. 

To Goodwill Account 
X. Capital Account {^) 

Y. do. a) 

A. do. (i) 

For shares in this asset treated as 
unrecorded. 



Dr. 



£900 

450 
450 



;^I,800 



F 2 



68 



PARTNERSHIP ACCOUNTS. 






I( 



In the result, A. is debited with ;^450 and X. 
and Y. are credited on balance with ^'300 and ;^i50 
respectively. This would forthwith reduce A.'s Capital 
to the sum of ;6 1,550, plus his interest in the Goodwill 
for what it was worth. 

The same result might have been obtained by 
omitting both the foregoing entries and making the 
following Journal entry : — 

A. Capital Account Dr. ^450 

To Sundries. 

X. Capital Account (§) 

Y. do. (i) 

For apportionment between X. and Y. 

of one-quarter share in Goodwill 

acquired by A. at the price of ^450. 

The contribution due from A. may be of a sum of 
;^2,ooo as his Capital, in addition to a payment by him 
for Goodwill. 

Suppose A., for example, to have contributed ;^'2,45o. 
The entries made in the Cash Book would have been : 



150 



To A. Capital Account 

To X. do. I amounts received from A. for ) 

To Y. do. ( purchase of share in goodwill ) 



I 

2,000 

300 
150 



In this case no Journal entries are necessary, the 
credits to X. and Y. respectively being effected through 
the Cash Book as a result of the extra amount of 
contribution by A. . 

Ordinarily there will be no record of Goodwill in the 
books of a partnershp until introduced at a valuation for 
some special purpose, such as the admission of a 



PARTNERSHIP ACCOUNTS. 



69 



partner, and, when the special purpose is accomplished, 
it is usual to find in the manner already shown that, 
bv transfer against the Capital Accounts, the Goodwill 
Account is eliminated and the asset becomes once more 
unrecorded. 

The i-ecord of Goodwill in the accounts of partner- 
ships has hitherto been dealt with only in regard to the 
admission of a partner, but may likewise become 
necessary upon death or retirement of a member of 
the firm. It may have been agreed, however, as to one 
or all the partners, that Goodwill shall not be brought 
into account in ascertaining the amount due to a retiring 
partner or a deceased partner's representatives. 

It is frequently the case that the partners have agreed 
as to tlie method of valuing Goodwill upon a dissolu- 
tion, and the terms of the partnership agreement then 
determine the valuation of the asset. 

The following are some of the many methods that 
may be found in partnership agreements : — 

That Goodwill shall be taken — 
(i) At a figure stated. 

(2) At a figure ascertained by an independent arbi- 

trator. 

(3) At an amount dependent upon the profits of one 

or more years preceding, or the average thereof. 

(4) At various amounts for individual partners, lupon 

the assumption that the value is affected more by 
the death or retirement of one partner than by 
that of another. 



I 



( 



70 



PARTNERSHIP ACCOUNTS. 



A partner may on retirement receive a given sum as 
his share of Goodwill, and yet such retirement may l3€ 
the direct cause of that Goodwill being considerably 
reduced, if not completely destroyed. 

The second method is usually not considered sufifi- 
ciently definite by the parties. Probably the third is that 
most frequently adopted. A change in the character 
and results of the business may render methods (i) and 
(4) unfair. This is sufficiently and thoroughly illus- 
trated by the case of Elliott v. Elliott. (See Chapter 
VIII.) 

Alethod number (3) may in some circumstances 
operate unfairly. There may be considered, for example, 
the valuation of the Goodwill of a firm under this 
method where profits have been consistently good for 
a period of years, and are then, owing to a world-wide 
financial crisis, succeeded bv losses for two or three 
years. Suppose the results to have been : — 

1908 Profits £42^^00 



1909 
1910 
191 1 
1912 



do. 
do. 
Loss 
do. 



46,100 

48,200 

2,000 

82,fXX) 



In the year 1913, the former succession of profits may 
be resumed. 

If Goodwill were to be valued, say, upon two years* 
purchase of the average of the profits and losses of the 
three years completed next prior to the death or retire- 
ment of a partner, there would be a remarkable variation 






PARTNERSHIP ACCOUNTS. 



71 



between the values upon (say) the 31st January in the 
years 1911, 191 2, and 1913; and the price to be paid to 
a deceased or outgoing partner would fluctuate consider- 
ably. At 31st January 1913, for example, the value 
would be nil, although it might even then be evident 
that profits would once more be earned and that the 
Goodwill had a substantial value. 

Where no agreement exists as to the rights of a 
deceased or outgoing partner in respect of Goodwill, it 
is, like any other asset, to be valued and the value 
brought into account. The general principles upon 
which such a valuation should proceed cannot be dealt 
with here. When ascertained, the deceased or retiring 
partner's account is to be credited with his share. 
Thus : — 



;^i..30O 



Sundries 


• ■ • 


Dr. 


To X. Capital Account ... 


• • ■ 


... 


A. Capital Account 


• • • 


... ;^65o 


jL t vlC/a • • • • • • 


• • ■ 


650 



For share in value of goodwill due to X, 
being one-half of ;^2,6oo. 

The amount due to X. is debited to A. and Y. in the 
proportions of the shares in which they, as betiveen 
themselves, succeed to the interest in the asset. The effect 
would have been the same if Goodwill Account had been 
opened at ;i'2,6oo and the Capital Accounts of the three 
partners, X., A., and Y., credited with £1^300, ;£?650, 
and ;^650 respectively ; and, subsequently, after ascer- 
tainment of the amount due to X., the Goodwill Account 
had been written back to the debit of A. and Y. to the 
amount of ;^ 1,300 each. 



PARTNERSHIP ACCOUNTS. 



73 



CHAPTER VI. 



ACCOUNTS UPON A DISSOLUTION.-I. 



The members of a partnership are free to make such 
agreement as they wish regarding the duration of their 
association in partnership and the circumstances under 
which dissolution is to ensue. 

Dissokition, subject to any agreement between the 
partners, will occur upon effluxion of the period for 
which the partnership has been entered into, or upon 
the termination of the specific trading venture in relation 
to which alone the partnership has existed. A partner 
will ordinarily have a right to terminate the partnership 
by due notice, but this right is frequently controlled by 
some agreement as to the time and manner of giving 
such notice. 

The death of a partner will ipso facto bring the 
partnership to an end as regards the deceased, but the 
position as between the surviving partners and the 
deceased's representatives is a matter that may be 
controlled by the partnership agreement. 

Bankruptcy of one partner, also, will ordinarily 
terminate the partnership as to that particular individual 
and the other members of the firm, but the partners 
in general may agree that the bankruptcy or death of one 



J 



shall not constitute ground for dissolution as regards the 
remainder. The partnership is dissolved ipso facto by 
the happening of any event which makes the partner- 
ship business unlawful, or by the assent of all the 
partners, or by a decree of the Court. 

In certain circumstances, it becomes possible for a 
separate creditor of one partner to obtain the appoint- 
ment of a receiver over, or the making of a charging 
order against, a partner's interest. This step will 
constitute ground for dissolution at the option of the 
other partners. The assignment by a partner of his 
share does not, in the absence of agreement to the 
contrary, give the other partner or partners an option 
to dissolve the partnership, as in the case of a charge 
upon a share, but the Court has power to order a 
dissolution, upon application of a partner, if " just and 
equitable," and might exercise the power in such 
circumstances. 

Whatever may be the circumstances which operate 
to terminate the partnership, the financial rights and 
interests of the partners in the firm must be ascertained 
as at the date of dissolution. An account therefore 
becomes necessary. 

The principles and method of preparation of such an 
account do not materially differ from what has been 
stated in regard to the annual or periodical accounts of 
a partnership. The account now under consideration, 
however, is the last that will be prepared as between 
the members of the partnership, and is therefore to 
be drawn up with the greatest possible exactness and 
accuracy. ' 



PARTNERSHIP ACCOUNTS. 



It is the account, not of a going concern, but of a 
completed venture. This will none the less be so 
because some of the members of the former partnership 
may have agreed to continue the business as a new 
partnership. 

The view of the dissolved partnership as a closed 
venture implies the preparation of such accounts as 
may constitute the basis of a complete and tinal 
settlement. 

It may be that there is a dissolution as regards all the 
partners, and the accounts will then show the amount 
due to each from the firm, that is, his interest in the 
firm's property and assets. More usually, dissolution 
will occur as to one or some only of the partners, leaving 
others who carry on the business, with or without other 
persons, in fresh partnership, in these circumstances, 
the account prepared upon the dissolution is frequently 
such as to show only the liability to the retiring partner, 
which may then be assumed by the new tirm. Such an 
account as that referred to may take note of the etfect 
of revaluation, but not usually of realisation, of the 
assets, for this latter may not then occur. 

Where, however, there is dissolution as regards all 
the partners, all of whom retire and desire to draw out 
what is due to them, a general realisation and conver- 
sion into cash become necessary. The interest of the 
partners in the assets is then dependent on the result 
of realisation, either piecemeal or of the business as a 
whole. 



PARTNERSHIP ACCOUNTS. 



O 



It is intended to consider here and to illustrate by 
example : — 

(i) Dissolution as to one or more, but not all partners, 
involving a valuation to arrive at the share of 
those withdrawing from the partnership. 

(2) Dissolution as regards all partners, involving 

realisation of assets piecemeal. 

(3) Dissolution as regards all partners and sale of the 

business as a going concern. 

In each of these cases it becomes necessary to prepare 
a Balance Sheet, which shall be made inclusive of all 
assets and liabilities under the control of or affecting 
the partnership, and wliich shall disclose the interest 
of the retiring partner or partners in the surplus of 
assets over liabilities. 

Where the ascertainment of the financial position is 
dependent upon either of cases (2) or (3) above the 
method of realisation involves an exact valuation, and 
no questions of great difficulty reed arise in this con- 
nection. In regard to case (i), however, many points 
arise for consideration, for a general revaluation cannot 
be based so exactly on market values as in the remain- 
ing cases. 

It has already been stated that the general principles 
laid down in regard to the annual accoimts apply with 
equal force to the accounts prepared upon a dissolution. 
They must be fair and, so far as is possible, exact ; all 
assets must be included and all reserves excluded, except 
such as are fairly necessary as a provision for antici- 
pated future losses in respect of present commitments 
of the firm. 



It 



76 



PARTNERSHIP ACCOUNTS. 



PARTNERSHIP ACCOUNTS. 



4 4 



The annual accounts of a partnership may not 
comply with these requirements, for partners are free to 
agree as they wish. Where values are unknown, and 
therefore a matter of estimate, partners in their annual 
accounts, as a matter of prudence, frequently under- 
estimate; further, they may not only underestimate, 
but ignore, values. 

Such errors in valuation caused by prudence or ignor- 
ance will not be binding in regard to the accounts 
prepared upon a dissolution. These must be just and 
true, and, while it is perfectly feasible for partners to 
make agreement as to the manner of their preparation— 
in regard to all or any of the assets— such agreement is 
not to be implied merely from a practice in regard to the 
annual accounts prepared in the past. 

Partners may, for instance, agree to arrive at profits 
upon a cash basis, making allowance only for increase 
or decrease in the totals of debtors and creditors, but 
ignoring stock-in-trade. Such a practice may be 
unwise, but this does not debar a retiring partner from 
claiming to bring the hitherto omitted asset into account 
upon a dissolution. 

Again, partners may have treated as Revenue expen- 
diture what might justly be regarded as Capital, and be 
possessed, therefore, of a (so called) secret reserve in 
the undervaluation or omission of certain assets; but 
this must be adjusted upon dissolution. 

What has been properly regarded as a Reserve 
(for contingent loss) in the annual accounts may 
be in whole or part a profit upon dissolution. Facts 



in illustration may be found on p. 20. In the 
case there given, it was stated, as the practice of a 
partnership, that a Fire Insurance Fund was created 
by a charge upon the annual profits of an adequate 
premium. In the lifetime of the partners the Fire 
Insurance Fund was regarded as a provision towards 
the risk of loss by fire. It could not be wholly regarded 
as profit. But, upon a dissolution, the considerations 
in question would no longer hold good. The firm 
would by that time have ceased to underwrite; its 
Underwriting Account would show a profit ; and in that 
profit all partners would be jointly interested. 

It has already been stated (Chapter V) that Goodwill 
is commonly an unrecorded asset. It may not necessarily 
be so, more particularly where it has been acquired by 
purchase, but the balance of argument is probably 
against its being maintained as an asset in the books 
of a partnership. However that may be. Goodwill is 
essentially an asset to be brought into account upon a 
dissolution. It must, with other assets, be brought in 
at a fair valuation. There may be, and frequently is, 
express agreement existing regarding the determination 
of its value, and where agreement exists, either in 
regard to this or any other asset, it is to be observed. 

Where no agreement exists, Goodwill will have to 
be realised or valued, together with other assets. It is 
to be sold for the benefit of all the partners, and there^ 
fore no one partner has any right to depreciate its value 
by purporting (after sale) to carry on the old business 
of the firm. He may represent himself as beginning a 



78 



PARTNERSHIP ACCOUNTS. 



PARTNERSHIP ACCOUNTS. 



(I 



new, but not as continuing the oldj business, unless he 
is, in fact, the purchaser. 

In the general question of ascertainment of the 
amount due to a deceased or retiring partner, the matter 
of proper valuation of Goodwill will be one of some 
considerable importance and difficulty. As this involves 
the consideration of general principles of accountancy 
which are not directly in point, the subject cannot be 
dealt with here. It can only be restated that — always 
barring agreement — Goodwill is an asset in which 
partners are jointly interested. It is, therefore, to be 
realised or valued for the benefit of all, and a retiring 
partner is entitled to receive his proper share of it. 

7'he treatment in accounts of a general revaluation 
to arrive at the amount due to the representatives of a 
deceased or to a retiring partner, may best be dealt with 
by example. 

Illustration. — 

A., B., and C. are partners in a firm of general brokers, 
sharing profits and losses as to — A. one-half, B. one- 
third, C. one-sixth. Interest on capital is allowed 
(per partnership agreement) at 5 per cent, per annum, 
and A. and B. receive salaries at the rate of ^^360 
and /"240 per annum respectively. A. retires as at 
30th September 191 2. 

No special provisions are contained in the articles of 
partnership, either as to ascertainment of a retiring 
partner's share or as to payment out of the amount due. 
The amount due to A. is therefore to be ascertained 
according to general principles, and will become due 



79 



and — in the absence of further agreement — payable, 
forthwith upon ascertainment. 

It appears, upon inquiry, that the practice of the firm 
has been to prepare accounts as at 31st December in 
each year. This can have no bearing in the present 
instance, except as determining the opening date for the 
account now to be prepared and therefore establishing 
the interest of the partners in respect of Loans, Capital, 
and undrawn Profits as at the opening date. It becomes 
necessary to prepare a Balance Sheet as at 30th 
September 191 2, together with the Profit and Loss 
Account for the period from ist January 191 2 to 30th 
September 191 2 inclusive. 

This Balance Sheet and the Account (which are sub- 
mitted on 30th November 191 2) are prepared according 
to the ordinary practice in the past, and take no 
special account of the circumstances necessitating their 
preparation. 

The balance of Profit and Loss Account is appor- 
tioned thus : — 

Account for period ist January 1912 to 30th September 1912. 



To Interest on Capital (9 months) 

A £600 

B 400 

C - 



Salaries (9 months) . . 

A £270 

B 180 

\^ • • • • « ■ ■ — — 



Current Accounts, for 

Shares in Balance — 

A., one-half . . £900 

B., one-third 600 

C, one-sixth .. 300 



s d 



1,000 o 



450 



By Balance 



1,800 o o 



£: 3,250 O 



£ s d 

3,250 o o 



3»25o o o 



8o PARTNERSHIP ACCOUNTS. 

A.'s Capital and Current Accounts are as follow : — 

A. Capital Accoint. 



PARTNERSHIP ACCOUNTS. 



8i 




,. l6,0vj0 o 



A. Current Account. 



1912 

Sep. 30 



To Drawings 
« Balance . 



£ S 'd 1912 

1 ,400 o o , Sep. 30 
370 o o 



£ 1,770 o 



By Interest on Capital j 
, Salary . . . . ! 
- Share in net Profit I 



C 

270 
900 



s d 

o o 

o o 

o o 



£"'1,770 o o 



By Balance . . 



370 o o 



The accounts submitted are prepared according to the 
customary manner, and have yet to be considered in 
regard to the questions of revaluation of assets as a 
whole. Before proceeding with this part of the subject, 
it is desirable to note the following points :— 

I. It is assumed that the partnership agreement has 
provided that the annual accounts, when pre- 
pared, shall be duly signed by the partners, and 
thereafter shall be conclusive. No questions arise, 
therefore, in regard to the accounts prepared as 
at 31st December 191 1. 
Neither A. (nor his executors, if he were deceased) 
have any right to participate in profits accruing 
after dissolution, either by way of interest, salary, 
or share in net profits. A.'s executors might 
have a right to interest, but it is interest on a debt 
rather than on a partner's Capital, for, upon A.'s 
death, his share in the assets becomes a debt due 
from the partnership to him. 



2. 






3. The accounts are not submitted until 30th 
November 191 2. A delay of some period is, of 
course, unavoidable, and the continuing partners 
are entitled to withhold payment until the retiring 

partner's share has been ascertained. 

« 

It now remains to consider some of the more 
important matters which may arise in regard to the 
valuation of assets for the purpose of ascertaining the 
share due to a deceased or retiring partner. 

The principles to be followed in arriving at a valua- 
tion to pay out one partner do not differ from those 
adhered to in relation to a general realisation upon a 
dissolution as to all ihe partners. In the former case, 
the assets are not actually realised, but are valued as 
if realised. They are treated as if they were, in fact, 
sold to the new firm by the old firm. 

From the reason that when there is a dissolution as 
to one of, but not all, the partners, the result of the 
*'sale" is only of interest for the specific purpose of 
arriving at the sum due to the retiring partner, it is not 
unusual to find that the result of the revaluation is not 
dealt with in the books of the firm, except so far as it 
affects the account of the retiring partner. In order 
that this may be the better understood, it should be 
stated as the general, though not invariable, practice 
that the books of the firm be continued in use notwith- 
standing the change in the personnel of the members of 
the partnership. 

In the case of valuation to pay out one partner, while 
the idea of sale is predominant, it must be remembered 



82 



PARTNERSHIP ACCOUNTS. 



that the values to be taken are those Hkely to be received 
upon sale as a going concern, that is, to the new firm. 
The result of such valuation is, therefore, commonly a 
higher figure than would perhaps be obtained upon a 
general realisation and liquidation. 

The question of valuation must be considered in 
relation to all partnership assets, but no others, and 
proper care must be taken to exclude assets w hich, while 
under the control or held to the use of the partnership, 
are the sole property of some individual partner. 

Upon a general revaluation there will occur cases of 
appreciation and of depreciation, and this under- or 
over-valuation may be found to have existed at the date 
of the previous Balance Sheet, thus causing (possibly) 
an error in the estimate given therein to partner^s 
Capitals and in the allowance for interest on such 
Capitals. 

There has already been set out on pp. 23-24 an 
example which may be taken in ilhistration. In the 
case there given, A. and B. made a *' paper" profit 
of X'230,000 by the sale of assets for ordinary shares 
in limited companies. The shares were written up to 
par in the books, and (by agreement of the partners) 
the *' profits" were credited to the partners* Capital 
Accounts in the agreed shares arranged under the 
partnership agreement. The profits carried to the 
Capital Accounts thus earn cumulative interest. 

This is immaterial, except upon death or retirement 
of either A. or B., for either partner will have been 



PARTNERSHIP ACCOUNTS. 



83 



credited with his due proportion of the " profit," and, 
if he is credited with interest on this addition to his 
Capital, will bear the charge for Interest on Capital 
in the Profit and Loss Account in just the same 
proportions. 

Where losses are not divided in the same ratios as 
profits, or changes occur in the basis of division, 
different considerations would arise. Ordinarily, how- 
ever, it will be a sufficient adjustment of the valuation 
of an asset in these circumstances to transfer the amount 
of the adjustment to the Capital Accounts of the 
partners interested in the proportions in which they 
have shared profits and losses. 

It may occur that Capital Expenditure has been 
charged to Revenue. There would then exist an asset 
which did not appear in the books and which should 
be introduced. 

There may be other assets not unrecorded, perhaps, 
but undervalued, for which an adjustment would be 
necessary. 

The general statement that assets are to be valued as 
if sold requires some qualification where the sale is from 
one set of partners to another, the latter being the new 
or '* continuing " set. Some allowance must be made 
for the deduction from the profit on sale that would be 
caused by the expenses otherwise incurred. 

In regard, for example, to the asset Stock-in-Trade, 

it might be quite unfair to the continuing partners that 

this should, for the purposes of paying out a partner, be 

brought in even at cost price. The retiring partner is 

G 2 



84 



PARTNERSHIP ACCOUNTS. 



entitled to have the benefit of the result of realisation, 
as if the partnership had, in fact, been dissolved as to 
all the partners and as if realisation had taken place. 
This would of necessity charge him with his due 
proportion of depreciation and the expenses of such 
realisation, and the deduction may reasonably be 
allowed for in valuing the asset. 

The Capital and Current Accounts of A., set out on 
p. 80, were such as resulted from the preparation of 
accounts as at the date of A.'s death, according to the 
customary practice. 

The Balance Sheet of that date is reviewed as a whole^ 
and the following Revaluation Account is prepared : — 



PARTNERSHIP ACCOUNTS. 



85 












a 
o 
u 
u 

< 

o 

H 
< 

< 
> 

H 



T3 



o O 
o o 



000 
000 



00 000 

« O 00 •«*M 
Vrt 1-1 W rr.30 M 



O 
O 

O 



O 

3 



3 






c y 



OS 



— o ° 






2 ."^ 



13 



c ^ 

C . 
9 en 



c 



■ 3 "C O >,t3 
^ o n'w o cB 

3 O a. « f— > in 
J50U -nOS 



O 

c • 
u 

',1 (O 

1—1 Q) 



'O'O 

=■2 

I I/) 

u n] 
O <a 

C/3 



o 

M 

C/5 



-a o o o 
„ o o o 

O m O 



o 
o 
o 



C 
3 
O 

u 
u 

< 



2 « 



S « O 

C -at 

2 • ■* 

^ !•- 

d to 

3 • = !3 

■ o c 

C/3 « rt 3 

C « "* C 

= o^ti 

n^3 3 

o 



o •*» 

O »nvo 



mvoao 
<s w o 
« ao_ ■>*; 



«■? .2 
u u u 

CCS 

000 



c 



(/3 



o 
o 

8 

rn 



o 

O 

8 






0) 

CI- 

c 
a; 



3 
O 
> 



c 

o 
y 
o 

<i1 



c 

u 



•a 











■7) 














\r, 


m 


m 


i ^t;? 


M 


o» 


0> 


«« 


«n 


>n 










1 


•* 




■* 



c 

a 

9 

W) 

c 

a 

a 

« 

M 

a 



9 



.s 

jB a 
(/3 o 

c ** 
(d C h 



ffjO 



c 
o 

tc 

3 
O 



§ 

•a 

n 



O 



O 









-a 







») c 


C 




in 
in 


ID 

in 





e 
o 



8 

o 



1 " 



o 



2*c- 



86 



PARTNERSHIP ACCOUNTS. 



The balance of this account, together with the balance 
of A.'s Capital Account U:i6,ooo), should be transferred 
to the credit of an account entitled " The Executors 
of A., deceased," which would then show a liability of 

;£^20,595. 



In regard to the Revaluation Account set forth, the 
following notes in addition to the matter already given 
mav be of interest : — 

Fire Insurance Fund, credit £14^320.— This repre- 
sents an accumulated gain upon fire insurance 
underwriting. The fund has hitherto been 
regarded as a provision towards accruing liabili- 
ties, but, upon the death of A., represents profit 
so far as the partnership of A., B., and C. is 
concerned. 

GoodivilL— The figure stated is the result of a valua- 
tion agreed to by all parties. 

/. Jones, Policy Account, and ]. Jones, debt.—]. Jones 
has hitherto appeared in the books as a debtor 
for ;i^i,25o (although he is a bankrupt, and no 
dividend has been or will be received from his 
estate), inasmuch as security is held in the form 
of a policy upon Jones* life for £3yOOO. The 
firm has paid the premiums upon this policy, and 
these have been charged to Revenue. The entries 
appearing in the accounts introduce the surrender 
value of the policy, and, per contra, the debt. 

The remaining entries present no special feature. 



I* 



PARTNERSHIP ACCOUNTS. 



87 



The raising of a Revaluation Account of the kmd 
set out has the effect of introducing into the books new 
figures in respect of various assets and liabilities. 

The continuing partners may, however, prefer to 
adhere to the former values. Goodwill, for instance, 
they mav prefer to have as an unrecorded asset; the 
Fire Insurance Fund they may prefer to regard as a 
provision towards loss; and the entries appearing in 
the Revaluation Account as a result of the inventory 
might be reversed as a whole so soon as the account 
had served the purpose of showing the further amount 
due to the retiring partner. 

The adjustment to former values by means of reversal 
of the entries alreadv made in the Revaluation Account 
will, of course, be made (in the example given) 
subsequent to the ascertainment of the amount due to 
the executors of A., and would, therefore, affect the 
continuing and new partners only. This is perfectly 
correct, for they have succeeded to the interest in the 
specific assets and liabilities affected by the revaluation. 

Thus, assuming that B. and C. continue in partner- 
ship upon the death of A., and succeed to A.'s share in 
profits proportionately to their existing shares, thus 
sharing A. two-thirds, B. one-third, the Revaluation 
Account would be continued, following on the entries 
as already given, thus : — 



1912 

Sep. 30 



To Sundries, reversal 
of entries at 
credit . . 



£ s d 

23,500 o 



I9I2 
Sep. 30 



23,500 o o 



By Sundries, reversal 

of entries at debit 

„ Current A/cs — 

B. §rds £5.633 6 8 

A.'jrd 2,816 13 4 




88 



PARTNERSHIP ACCOUNTS. 



The effect upon the Current Accounts of B. and C. 
is to leave them charged net — 

B. with {£5.6ss : 6 : 8, less £2,Si6 : 13 : 4) = ;£2,8i6 : 13 : 4 

C. with {£2,Si6 : 13 : 4, less ^1,408 - 6 : 8)-;£i,4o8 : 6 : 8 

together accounting for the amount, ;t'4,225, credited 
toC. 



Where the continuing partners desire to ignore the 
results of the revised valuation in the books, the 
Revaluation Account obviously has practical bearing 
only upon the account of the retiring partner, and 
might then be ignored except so far as he is concerned. 
Thus : — 



H 

O 

u 
•J 

< 

o 

H 

< 

< 



/ 



PARTNERSHIP ACCOUNTS. 



89 



•t3 


■*ao 







tn 


ro\0 







«^ 




irj 





•B 














(A 
















r> 


«r> 


10 


>r) 


V*? 


k 


N 


c> 


C\ 


row 


«r> 


in 






■♦ 




t 



C !2 C 



Had 

s 
O 



o 
t/5 



(0 

Si 



•- V 

« a. 

tc 

o « 

0-3 

o-o 

2c 
a.2 

2 3 

. « 
*r > 

C V 

3 ^ 

O c 

O o 

" a 



fc 1; « 

3 « s 

O C.3 
Sl o 















>o 


U-) 


N 


N 


W 


W 






"♦ 


•>? 



H 
Z 

D 

O 

u 

u 



H 
Z 

H 

D 

V 



G 

.2 



o 



•c o 






o 
C/5 



e 
o 

3) 



O 



o 



V 

c 

2Q 



o 
o 



trt 



'-41 



90 



I'AKTNERSHIP ACCOUNTS. 



It is obvious that a general revaluation will, in many 
instances, be likely to raise questions not to be deter- 
mined without some difficulty. For this reason partners 
not infrequently make definite agreement as to the 
method of arriving at the amount due to a partner upon 
his retirement or to the representatives of a partner in 
the event of his death. The terms of such agreements — 
usually expressed, of course, in properly drawn articles 
of partnership — necessarily vary, but will, as a rule, 
cover the ascertainment of the outgoing or deceased 
partner's share in Goodwill and/or the whole of the 
partnership property. The following may be afforded 
as an illustration : — 

Upon retirement or death of any partner, the sum 
due to him or his representatives shall be taken to 
be the amount appearing due to him in the last 
accounts prepared for the purpose of ascertaining 
the financial position and profits of the partnership 
prior to his retirement or death, plus interest thereon 
at 6 per cent, per annum in lieu of profits since that 
date, bringing into account also the balance of any 
Current Account as appearing at such date and 
subsequent drawings; with the following addition for 
Goodwill, that is to say, a proportionate part 
equivalent to his share in profits at the time of his 
retirement or death, of the value of the Goodwill, 
calculated upon two years' purchase of the average 
of the profits of the last three years up to the 31st 
December next preceding his retirement or death. 

The interpretation of such clauses may occasionally 
give some difficulty in reference to the facts of some 
particular case. 



PARTNKKSHir ACCOUNTS. 



91 






Such agreements mav operate to benefit or affect 
prejudicially the estate of a deceased partner accordmg 
as trading Results immediately prior to death have been 
bad or good (see p. 70), but are valid and binding both 
upon the continuing partners and upon the retiruig 
partner or the representatives of a deceased partner. 

" Subject to any agreement between the partners, the amount 
due from surviving or continuing partners to an outgoing partner 
or the representative of a deceased partner in respect of the out- 
goinc. or deceased partner's share is a debt accruing at the date 
of th" dissolution or death." (Section 43, Partnership Act, 1890.) 

Although the terms of the section quoted fix the 
maturitv of the debt as at the date of " the dissolution 
or death," it is obviously impossible in the majority 
of cases for the accounts to be prepared immediately, 
and some delay must necessarily ensue. Section 42 of 
the Act provides against unreasonable delay, and is 
as follows : — 

Section 42.— (i) Where anv member of a firm has died or other- 
wise ceased to be a partner, and the surviving or continuing 
partners carrv on the business of the firm with its capital or assets 
without anv final settlement of accounts as between the firm and 
the outgoin<^ partner or his estate, then, in the absence of any 
a^^reement to the contrary, the outgoing partner or his estate is 
entitled at the option of himself or his representatives to such 
share of the profits made since the dissolution as the Court may 
find to be attributable to the use of his share of the partnership 
assets, or to interest at the rate of 5 per cent, per annum on the 
amount of his share of the partnership assets. 

(2) Provided that where by the partnership contract an option 
is given to the surviving or continuing partners to purchase the 
interest of a deceased or outgoing partner, and that option is duly 
exercised, the estate of the deceased partner, or the outgoing 



92 



PARTXERSH I P ACCOUNTS. 



partner or his estate, as the case may be, is not entitled to any 
further or other share of profits ; but if any partner assuming to 
act in exercise of the option does not in all material respects 
comply with the terms thereof, he is liable to account under the 
foregoing provisions of this section. 

In regard to Subsection (i), doubt has been expressed 
as to whether interest runs as a matter of course from the 
death. The amount due to a deceased partner's repre- 
sentatives is not known until the account is prepared, 
and until this is done, no debt can be stated, but it 
is submitted that the 5 per cent, interest (if chosen in 
lieu of profits) runs from the date of dissolution until 
the final settlement of the accounts. 

In connection with this section attention is drawn 
to the words in the first sub-section, *' attributable to 
the use of his share of the partnership assets." There 
is no rule that the profits are divisible in the same 
manner as prior to dissolution, and no doubt some 
allowance would be made for the energy and skill of 
the surviving and continuing partners, but the section 
is intended to prevent undue delay of the final settle- 
ment, and the option conferred as regards profits or 
interest must be regarded to some extent in the nature 
of a penalty imposed upon the surviving or continuing 
partners. 



A revaluation or determination of the share due to an 
outgoing or deceased partner may occur many times in 
the history of a firm trading continuously under the same 
name. Fresh persons may be admitted from time to 
time, existing partners may retire or die, and new 
partnerships will succeed. 



PARTNERSHIP ACCOUNTS. 



93 



Each set of partners sells at a price to the succeeding 
set; the old set will divide the price in the proportions 
already agreed; the purchasing set will be charged in 
the new proportions with the purchase money, for it is 
in the new proportions that they will be credited with 
any subsequent benefits. 

In illustration of the matter as a whole, and as an 
example of the problems that occasionally arise, the 
following case is submitted. 

A., B., C, D., and E. entered into partnership on 
ist October 1906. As a firm they have an insurable 
interest in X., who is not a member of the firm. They 
accordingly insure X.'s life for ;£^3,ooo, at an annual 
premium of £102, which is debited each year to the 
Profit and Loss Account, and, despite changes in the 
firm from time to time, the value of the policy has been 
excluded from the accounts. 



The partners share as follows : 

A. . 

B. . 

C. . 

D. . 

E. . 



45% 
23% 
i9?o 

6% 



On ist October 1909 they admit into partnership F., 



and the profits are tl 

A. . 

B. . 

C. . 

D. , 

E. . 

F. . 



en distributed as follows : — 

42% 

21% 

18% 

7% 

6% 

6% 



94 



PARTNERSHIP ACCOUNTS. 



On isi October 1910 they admit G., and divide in 
the following proportions : — 

/V* ... 

B. ... 



C 

D. ... 
E 
F 

G, ... 



38% 



15/0 



20?4 



80/ 



.-0/ 



6% 
6% 



The partnership deed provides that, in the event of 
the death of a partner, his interest shall be deemed to 
continue until the 30th September following. 

On 23rd February 191 2 D. dies, and his interest in 
the firm ceases on 30th September 191 2. The policy on 
the life of X. has a surrender value and the following 
questions are raised : — 

1. I low is D.'s share in this surrender value to be 

determined? 

2. How should the partners other than D. contribute 

the amount owing to D. in respect of his share 
of the surrender value? 

(3) Supposing X. to die, in what shares should the 
continuing partners benefit from the policy 
monevs ? 



PARTNERSHIP ACCOUNTS. 



95 



Before proceeding to deal with these points, it is 
necessary to set out the fresh proportions agreed on as 
at I St October 191 2, which were : — 



A 

A*.* ••• •■• «• 

c 

F 
F 

Ml. • m m m ••■ •« 

G 

H. (new partner) 



>3 



2% 

, - 0/ 
I 5/0 

22?/o 

II?/o 



6% 
6% 



Each set of partners must be viewed as a separate 
partnership, which will be designated respectively as 
the first, second, third, and fourth. 

The first partnership transfers its interest in the policy 
to the second partnership, the consideration being the 
value of its interest at the time of transfer. 

The second partnership did likew^ise, under similar 
conditions. 

The third partnership acquires in similar fashion 
from the second, and the fourth from the third. 

Each set of partners sells at a price and divides in 
certain proportions, and the purchasing set of partners 
are charged in the neiv proportions with the purchase 
money, because (as has been stated) it is in the neiv 
proportions that they will be credited with any subse- 
quent benefits. 

The value of the policy must be ascertained as at 
ist October 1909, ist October 191 o, and ist October 
191 2, and dealt with accordingly. 



96 



PARTNERSHIP ACCOUNTS. 



D.'s represenlatives have no claim except in respect 
of the value as at 30th September 191 2. Tiiey cannot 
insist upon the continuing partners keeping the policy 
in force, and any gain accruing over and above 
surrender value after that date, and after D.'s repre- 
sentatives have assigned or agreed to assign the policy, 
will concern the continuing partners only. 

The first partnership will have paid in premiums 
^306; assume the surrender value of this to be ;^95. 

The second partnership will have paid £102-, assume 
the value then to be ;£;i28. 

The third partnership will have paid ;^204; assume 
the value at 30th September 191 2 to be £22>,. 

To find the correct apportionment of the value as at 
30th September 191 2, and therefore of the amount due 
to D.'s representatives, the first value will be credited 
to the first set of partners in the first proportions given, 
and debited to the second set in the new proportions ; 
the second set will be credited with the second value' 
stated in the proportions of the second partnership, and 
the third set debited. Finally, the third set (including 
D.) will be credited as at 30th September 191 2, and the 
fourth set debited. Upon the balance of the adjustments 
made in this way will be ascertained the proper appor- 
tionment of the amount due to D.'s representatives. 

It will be observed that incoming partners purchase 
a share. H., in the last partnership, will be debited 
with 6 per cent, of ^^225, for it is in that proportion that 
he will derive benefit from the policy in future. 



PARTNERSHIP ACCOUNTS. 



97 






In the following table the amount due to or from 
each partner in respect of the surrender value is set 
out :- - 





1st 
Partnership 


and 
Partnership 


3rd 

Partnership 


4th 
Partnership 




Dr. 


Cr. 


Dr. 


Cr. 


Dr. 


Cr. 


Dr. Cr. 




£ 


£ 


£ 


£ 


£ 


£ 


£ £ 


A. 


... — 


42-75 


39-90 


5376 


48.64 


85-50 


72.00 — 


B. 




21.S5 


^9-95 


26.8S 


19.20 


33-75 


33-75 


C. 


... — 


1S.05 


17.10 


23.04 


25.60 


45.00 


49-50 — 


D. 




6".65 


6.65 


8.96 


10.24 


18.00 


— — 


E. 




5-70 


5-70 


7.68 


S.96 


15-75 


24-75 - 


F. 






5-70 


7.68 


7. 68 


13-50 


iS.oo — 


0, 






— 


— 


7.68 


13-50 


13.50 — 


H. 




— 


— 


— 




— 


13.50 — 




^'95 


^95 


£^2S 


^■128 


;^225 


/-■225 



The net adjustment upon cancelling the figures above 
appears as follows : — 









£-s 


d. 




£ 


s d. 


c. 


pays 




6 2 


3 


A. receives 


... 21 


9 5 


E. 


11 




10 5 


7 


B. „ ... 


9 


n 8 


F. 


)i 




... 10 4 





D. „ ... 


... 16 


14 5 


G. 


»i 




— 7 13 


8 








H. 


11 




... 13 10 

















£47 15 


6 




£47 


15 6 



H 



CHAPTER VII. 



ACCOUNTS UPON A DISSOLUTION.— II. 



There have yet to be considered the questions of 
account arisinf^^ upon a, dissolution and discontinuance 
of the business as reg^ards all the partners*. Under these 
circumstances, as there are no continuing partners, the 
a.ssets must be reahsed. Reahsation may be bv sale of 
the business as a f::oing concern, or piecemeal. It will 
be necessary in every case to open a Realisation or Sale 
of Business Account, which will ultimately show in 
gain or loss the result of realisation. 

A sale of the business as a going concern will not 
ordinarily present any considerable difficulties in regard 
to the accounts. It will merely be necessary to transfer 
the assets and liabilities to the Realisation Account, to 
which will be credited the sale price. 

The following example is submitted in illustration : — 

Three partners, A., B., and C, decide to retire from 
business. 'I'hey therefore enter into a contract to dispose 
of their business as a going concern as from ist January 
1913 at the price of ;{^ 15,000, inclusive of goodwill 
and all other assets, and the liabilities, except liabilities 
to partners, as shown by the firm's Balance Sheet of 
30th June 191 2, together with an addition to the price 



PARTNERSHIP ACCOUNTS. 



99 



of 10 per cent, per annum interest upon the purchase 
money from the 30th June 1912 to the 31st December 
191 2, such addition to be inclusive of all profits made 
between the dates named. The Balance Sheet (sum- 
marised) as at 30th June 1912 was as follows : — 



Ltabilities 

Sundry Creditors 

A. Loan Account 

Capital Accounts— 

A £4.260 

B 2,870 

C 3.557 


£ s d 

4,219 
1,200 

10,687 


A ssets 

Office Furniture and Fittings 
at Cost, less Depreciation 

Patents, Irademarks, &c., at 
Cost, less Depreciation . . 

Stock in Trade 

Sundry Debtors 

Bank of England — 
Balance to Credit . . £4,250 

Cash in hand . . . . 46 


£ s d 

350 

1,320 
4,760 
5,380 




4,296 


£ 


16,106 


£ 

1 


16,106 









In due course, the Balance Sheet is prepared as at 
31st December 191 2, and is here set out in a form 
adapted to show the eventual result, but excluding 
interest due to the vendors :— ^ 



Liabilities 

Sundry Creditors 

A. Loan Account 

Capital Account as at 30th June 
1912— 

A £4.260 

B 2,870 

C 3.557 

Profit and Loss Account — 
Balance to Credit . 


£ s d 
4,240 

I,200 

10,687 ' 

1,433 


Assets 

Office Furniture at Cost, less 

Depreciation 
Patents, Trademarks &c., at 

Cost, less Depreciation .. 
Stock in Trade 
Sundry Debtors 
Bank of England— 

Balance to Credit £4,321 
Cash in hand . . . . 120 


£ s d 

310 

1,170 
4,919 
6,720 

4,441 


£ 


£ 


17,560 


17,560, 









Following the preparation of the Balance Sheet it 
becomes possible to construct the following accounts by 
means of the proper Journal entries, which are deemed 
to have been made as at 31st December 191 2 



H 2 



lOO 



PARTNKKSH I P ACCOUNTS. 



Realisation Account. 



To Sundry Assets 
. Balance carried down 



£ s d 

17,560 o o 

a,43o o o 



£ 19.990 o o 



To Current Accounts, for 
Shares in Profit — 

A. one-half 

B. one-third 

C. one-sixth 



s (I 



1,215 o o 
810 o 
405 o c 



2,430 o o 



By Sundry Creditors 
, Purchasers — 

For agreed price 
For Interest at 10% per 
annum for period 
30th June 1912, to 31st 
December 1912 



I s d 
4,240 O 

15,000 o o 



750 o 



19,990 o o 



£ s d 
By Balance brought down. . 2,430 o o 



£ 2.430 o o 



Note.— These illustrations exclude questions of (ncome-tax. 



Purchasers. 



£ s d 

To Realisation Account, for 

Purchase Price . . . . 15,000 o o 
« Realisation Account — 

Interest 750 o o 



I 15,750 o o 



£ s «1 
By Profit and Loss Account, 
Half-year's Profits 

accruing to Purchasers 1,433 o 

• Cash 14.317 o o 

/ 15,750 o 



The Balance Sheet as at 31st December 191 2, as 
ahered by these further entries, will now appear : — 



Liabilities 

A. Loan Account 

Capital Accounts — 

A £4.260 

B 2,870 

C 3,557 

Current Accounts — 

A 1,215 

B 810 

C 405 

/ 



£ s djj 

1,200 o o ' Cash 



10,687 o o 



4 asets 



£ « '1 

14.317 O 



2,430 o o 



14.317 o o 



/ 14,317 o o 



PARTNEUSHIP ACCOUNTS. 



lOI 



It is of some importance to remark that the balance 
of Realisation Account— whether profit or loss— is 
divisible according to the basis agreed upon for ordinary 
trading profits and losses, for it is in these proportions 
that the partners have agreed to contribute to any 
deficiency or loss of Capital caused by trading. The 
point is further considered in reference to the case of 
Noiiocn V. ycmcll (7 Equity, 538 (1869).) (See pp. 

I03-4-) 

Where the method of realisation is that of piecemeal 
sale, the ultimate result naturally takes somewhat longer 
to obtain. The form of the Realisation Account is also 
somewhat different, for to this account there will be 
transferred, not the balances of the accounts of assets 
and liabilities as appearing prior to realisation, but as 
they appear after the cash received has been credited to 
the Asset Accounts and the cash paid has been debited 
to the Liabilities Accounts; that is, there will appear 
in Realisation Account the net gain or loss upon the 
realisation of each class of assets or discharge of each 
class of liabilities. 

Illustraiiou. — The following is the Balance Sheet of a 
partnership consisting of two members, A. and 
B., sharing equally : — 



Liabilities. 

Sundry Creditors 
Capital Accounts— 

Am « • • • 

B 





£ s d| 


. . 1 2,630 


£2,330 

435 


1 
2,765 


£ 


5.395 







Assets. 

Furniture and Fittings 
Stock-iivTrade 
Sundry Debtors . £3.518 
Less Reserve for 
Bad Debts . . 245 



Cash 



142 o 

1,860 o o 



3.273 o 

120 O 



£ 5.395 o 



102 



PARTNKKSH 1 1» ACCOL N TS. 



The assets are realised, and produce : — 

Furniture and Fittings ;t45 

Stock-in-Trade ... 1,215 

Sundry Debtors 3»i20 

Goodwill ... ... ... ... 250 

The actual amount owing to creditors is found to be 
£2y'jS6 and the expenses of liquidation amount to /'150. 

Upon the basis of the figures given, the Realisation 
Account would appear as follows : — 



To Losses on Kealisation of— 
Furniture and Fittings 
Stock in Trade 
Sundry Debtors {see Reserve 

contra) 

a Further charge in respect of 
Debts due to Sundry 

Creditors 

, Expensesof Realisation and 
Liquidation 



£ 


s 


d 


97 
645 











1 


398 





1 



156 








150 








1446 








1 


"" 


^ 



By Gain on Realisation of 
Goodwill 
« Reserve for Bad Debts 
Current Accounts — 

A. one-half ^'475 los. 

B. do. 475 los. 



250 o o 

245 G O 



951 o o 



jf, 1,446 O O 



The result of the realisation is as follows : — 



Ualance Sheet. 



Liabilities 
Capital Accounts — 

B 



£ s d 

2,330 o o 
435 o o 



£ 2,765 o o 



Assets 
Cash . . . . .. 

Current Account — 

A £475 los. . 

B 475 IDS. 



1,614 o o 



951 o o 
£ 2,765 o o 



I 



Upon the position as here shown, A. is entitled to 
take the whole of the cash balance and to call upon B. 
to pay up a further £^o los. 

The principles of construction of the Partnership Act, 
1890, in reference to another aspect of the facts of the 



PARTNERSHIP ACCOUNTS. 



lO' 






last illustration are of so much importance that it is 
desirable to quote the provisions of Section 44 {a) of 
the Act. 

In settling accounts between the partners after a dissolution 
of partnership, the following rules shall, subject to any agreement, 
be observed : — 

(a) Losses, including losses and deficiencies of capital, shall 
be paid first out of profits, next out of capital, and lastly. 
% if necessary, by the partners individually in the proportion 
in which they were entitled to share profits. 

In the interpretation of this section some reason will 
be found for the distinction already drawn between the 
fixed " fund " of Capital and the Profits accruing due 
to the partners. It has been stated that Capital is to be 
maintained, by due and proportionate contributions 
towards losses, if necessary; while profits may be 
withdrawn. 

The intention of the Subsection (a) is that losses shall 
first be brought into account as against partners' 
undrawn profits ; next, as against Capital ; finally, that 
they shall be made up by actual cash contributions to 
the firm, wiiere Capital is extinguished. It may be best, 
for purposes of illustration, to consider Subsection (a), 
and, in particular, the words " losses and deficiencies of 
Capital," by reference to the case, Xowell v, Xoivell 
(7 Equity, 538 (1869)), the actual figures of the case 
being modified for greater convenience in explanation. 
In this case there were concerned two partners, Thomas 
and Jacob Nowell, who had contributed as Capital 
approximately ^'1,929 and £2g respectively. 



I04 



PARTNERSHIP ACCOUNTS. 



PARTNERSHIP ACCOUNTS. 



105 



The partnership agreement was by parol, and the 
facts were accordingly to be construed by the interpreta- 
tion of the general law relating to partnerships. 

The parol agreement provided (by implication) for 
equal shares in profits, and, nothing being stated or 
agreed otherwise, for equal shares in losses also. 

Upon the death of Jacob Nowell, the assets of the 
firm amounted to ;^i,400 only, resulting in a consequent 
"deficiency of Capital" of approximately £^>,8. 

It was thereupon submitted on behalf of Jacob Nowell 
that the loss was mainly to be borne by Thomas 
Nowell's estate, inasmuch as it was his Capital, being 
so much the larger, which might be said to be 
"deficient," but it was decided that this was not the 
correct legal position. 

It has already been made clear that a debit balance 
on Profit and Loss Account is to be brought into 
account to the debit of the partners in equal shares, and 
that a loss on the realisation of an asset is to be similarly 
treated. Here various losses upon many assets had 
occurred. There were originally assets totalling ;{;i,958; 
there was now ;t'i»400 cash only, and a loss of 
approximately £^^S had therefore arisen. 

Towards this loss each partner was liable (in the 
currency of the partnership) to contribute (unless other- 
wise agreed) equally, as and when the loss was ascer- 
tained; upon a dissolution, one-half share of the loss 
was to be treated as due in account from each partner. 
"Capital," in other words, "is in itself a partnership 



" debt, to be made up by contribution, if the assets are 
" insufficient, in the same way as other partnership 
'' losses; not in proportion to the partners' shares in the 
*' Capital, unless it appears, as in Wood v. Scoles (1866, 
"L.R., I Ch. 369), that such is the intention of the 
*' partners on the true construction of their agreement." 
(Pollock.) 

Some further consideration of the terms of Section 44 
of the Act is given later in reference to the application 
of assets upon a dissolution. 

It has already been observed (p. 63) that, although the 
partnership may have the use of some particular asset, it 
mav not for that reason represent partnership property. 
If such is the case, the partners as a whole will not then 
be interested in the realisation of the asset in question. 

Thus, A., a partner, has, with the knowledge of his 
co-partners, entered into a private transaction in the 
name of his firm involving the purchase of a quantity 
of goods, upon the understanding that the result of the 
transaction, subject only to 5 per cent, commission on 
the sales which is to accrue to the firm, is to affect 
A. only. 

The o-oods in question have been introduced into the 
firm's books in the ordinary way, and are unsold at 
the date of dissolution. They are ultimately sold at a 
lo.>s. 

The loss realised, allowing for commission due to the 
Profit and Loss Account of the firm, wdll be transferred 
in due course to the debit of A., and the position 
between the partners inter sc will be properly adjusted. 



io6 



I'AKTNKUSHIP ACCorMS. 



The sale of assets may take place, as to whole or part, 
for a consideration in the form of shares; or again, 
during the period of the partnership, partners may 
have entered into transactions involving the acquisition 
or receipt of shares. These shares will be held 
as partnership property. Loss or prolit in respect of 
them, whether realised at or prior to dissolution, affects 
all the partners. Whether acquired prior to dissolution 
or in the realisation consequent on dissolution, the 
shares are to be realised or apportioned amongst the 
partners at a valuation. 

Realisation may be difficult or inadvisable; and yet 
valuation may be impossible upon any satisfactory basis. 

The proper procedure would then be to divide the 
shares in specie, giving to each partner a holding in 
shares proportionate to his share in protit or loss, and 
adjusting the resultant balances upon the Capital 
Accounts by a cash payment. 

The following Balance Sheet shows a position in 
illustration of the procedure recommended : — 



Liabilities 

A. Capital Account 

B. do. 



£ s d 



A ssets 



4,000 o o [ Cash 

1.200 o : Shares in X.Y.Z. Mining; 
Company, Lini., 2,000 £1 
each fully-paid, valued 
originally at par . . 
I Lo-s on Realisation . . 



£ s d 
2,400 o 



2.00D O O 
^OO o o 



£ 5,aoo o o 



S,2C0 O O 



The simplest method of settlement as between A. and 
B., who share equally, would be as follows, assuming 
it not to be possible to arrive at a satisfactory realisation 



PARTNERSHIP ACCOUNTS. 



107 



or at a valuation mutually acceptable as between the 
partners, viz. : — 

A. to be debited with one-half of the loss on realisa- 

tion to date, /;400, and to take one-half ot the 
shares, 'leaving him a creditor (on book hgures) 
for ^,'2,600 to be paid to him in cash. 

B. to be similarly charged in respect of the loss and 

shares, leaving him a debtor (on book figures) 
for ;£^200. 

1^. would consequently pay ^,200 to A., who would 
also take the cash balance, ^'2,400. 

By giving to A. and B. holdings in shares propor- 
tionate to their interest in profits and losses, it becomes 
immaterial whether profit or loss results from their 
realisation, for each partner is interested in (jne-half of 
the firm's original holding. 

This method may not always be satisfactory. The 
proportions of profits may not be the same as those of 
losses ; it may be quite uncertain whether profit or loss 
will result; no acceptable valuation or realisation may 
be possible. It will then be necessary to defer the 
adjustment consequent upon the eventual result until 
actual realisation or a valuation agreeable to all parties 
can be made. 

Where valuation takes place and is accepted (as it 
must be to be binding) by all the partners, it is 
immaterial how the shares are applied. They may be 
divided proportionately to shares in Capital, or profits. 



i 



i| 



io8 



PAUTXERSHIP ACCOUNTS. 



or taken by one partner, as may be agreed. The 
valuation brings into account their full value in ascer- 
tainment of the result of realisation. The transfer of 
the shares, or any part of them, at that value operates 
in satisfaction pro tanto of the amount due to any 
individual partner. This might be said to apply to any 
asset of the partnership. 

No partnership will ordinarily exist after the date of 
dissolution in respect of any part of the partnership 
property, except so far as ma\- be necessary for prepar- 
ing the accounts as between the partners upon the 
dissolution. 

Thus, in a case somewhat similar to that last gi^^en, 
the partners may each receive a part of some quantity 
of shares realised in respect of the assets. Suppose such 
shares to be partly paid up. One partner may sell his 
holding at a substantial premium above the value at the 
time of transfer to him. The other may hold ; he may 
eventually be called upon in respect of the uncalled 
portion of his holding, and ultimately lose heavily in 
the liquidation of the company in which the shares are 
held. The gain of the one partner and the loss of the 
other are not partnership transactions. 

The partnership may have ceased earlier in respect 
of the particular asset of the shares, for these may, by 
mutual agreement, have been withdrawn from the 
partnership, and taken over by the partners (as indivi- 
duals) at an earlier date; but in this case there would 
have to be some proper evidence of the agreement. 



CHAPTER VIII. 



ACCOUNTS UPON A DISSOLUTION.— III. 



Application of Assets. — Rights of Partners 

Inter se. 
The interpretation of Section 44 in reference to a 
*' loss upon realisation " has been given, but the section 
is now set out in full in its reference to the subject- 
matter of the present chapter. 

Partnership Act, 1890. 
Section 44. — In settling accounts between the partners after a 
dissolution of partnership, the following rules shall, subject to any 
agreement, be observed : 

(a) Losses, including losses and deficiencies of capital, shall be 
paid first out of profits, next out of capital, and lastly, if 
necessary, by the partners individually in the proportion in 
which they were entitled to share profits : 

(b) 'J'he assets of the firm, including the sums, if any, con- 
tributed by the partners to make up losses or deficiencies 
of capital, shall be applied in the following manner and 
order : 

(i) In paying the debts and liabilities of the firm to 
persons who are not partners therein : 

(2) In paying to each partner rateably what is due from 
the firm to him for advances as distinguished from 
capital : 

(3) In paying to each partner rateably what is due from the 
firm to him in respect of capital : 

(4) The ultimate residue, if any, shall be divided among the 
partners in the proportion in which profits are divisible. 



no 



PARTXEUSH I P ACCOUNTS. 



As partners have not the advantage of limited liability 
to the firm^s creditors, a partner may be called upon to 
pav up some greater amount to satisfy the claims of 
creditors than would be due from him if assessed pro 
rata with his co-partners. 

This would be caused by the failure of a co-partner 
to contribute his proper share. 

Illustration. — Balance Sheet showing position at date 
of dissolution as between two equal partners : — 



Liabilities. 

Sundry Creditors 
Cipital Account : 

A. . . £2,000 

B. .. 800 






£ s d 
1,200 

2,bO0 


1 

Ci 
L« 

1 

1 


Assets. 

ish 

5SS on realisation, due 
from— 
A., one-half 

share .. £1,500 
B., one-half 
share .. 1,500 


£ s d 
1,000 






3,000 






. 


£4,000 




£4,000 






1 




The position may 


be further 


simplified as follows : — 


Liabilities. 

Saadry Creditors 
A., due to him 


• • 

■ 


£ s d 

1,200 

500 


1 

1 Asstts. 

Cash 

1 B., due from him 


£ s d 

1,000 

700 




£1,700 


£1,700 













As between A. and B., B. is liable to pay in ;^2oo to 
satisfy the claims of creditors and a further ;£.'500 to 
adjust his position as regards A. 

B., however, is not able to pay in anything. A. 
accordingly pays in ^^200, placing him in credit to the 
amount of /'700. The claims of the sundry creditors 
can then be satisfied, and A. is left with his remedy 
against B. for /'700. 



PA RTXKRSM I P ACCOUNTS. 



Ill 



The liability for ordinary partnership debts being a 
joint one, the creditors have, of course, the right to 
come on any member of the firm for satisfaction of 
their claims. Should one of them be adjudicated 
bankrupt, his discharge would operate to release him 
from his joint, as well as from his separate, debts, and 
this release would apply to claims existing as between 
partners inter se. 

Advances by a partner in a dissolution may be a 
matter of necessity. They may be made temporarily to 
facilitate the liquidation of the firm's afifairs; for some 
advantage may often be obtained by paying ofT creditors 
without delay, and advances may also permit of the 
postponement of the realisation of the assets with better 
ultimate advantage. 

No interest is pa}'able in respect of such advances 
after the date of dissolution, unless expressly agreed for. 

In accordance with the terms of Section 44 (b) of the 
Act, the advances would be repaid in priority to the 
claims of the partners in respect of Capital, subject, 
ho\\ever, to remarks below. 

As regards the application of the assets, the terms of 
Section 44 are fairly clear. The order given therein 
is : — 

(i) Creditors of the firm. 

(2) Partners for advances. 

(3) Partners for Capital. 

(4) Partners for ultimate residue (if any). 



112 



PARTNKRSHIP ACCOUNTS. 



The application of the assets in satisfaction of the 
claims of creditors requires no explanation, but as 
regards the claims of partners, whether for advances or 
Capital, an account should be taken of the position as a 
whole, for, as a protection to the partners generally, 
payments should not be made to one partner in respect 
of advances, if it be considered probable that a contribu- 
tion will be found due from him as a resuh of the 
winding-up of the affairs of the firm. 

Where the settlement of the firm's affairs extends over 
a considerable period, it may be desirable (creditors 
having first been paid) to make periodical distributions 
of sums in hand to the partners. 

The apportionment of the result of realisation cannot 
be made until it is completed, but the distribution can 
be proceeded with on the basis of " cancelling down " 
the Capital sums of the partners respectively, so that 
they shall bear to each other the same proportions as 
those in which profits and losses are shared. But 
interim distributions among partners can only be made 
cautiously and upon the assumption that any partner 
becoming indebted to the firm in the final adjustment 
will be able to meet such indebtedness, for otherwise 
the decision in Garner v. Murray (see later) will apply. 

Example. — The position of the firm of A., B., and C. 
on 31st December 191 1 was as follows : — 



Liabilities. 



Sundry Creilitors 
Capital Accounts : 

j\ * ■ • • • 

B 



£3.300 
5.400 
1.800 



Paid 


d 


10,500 





£■10,500 







t 



Assets. 
Sundry Accounts 



lo'soo o o 



rio,5iX) o o 



PARTNERSHIP ACCOUNTS. 



113 



Shares in profits and losses were, as to — 

A. .'.,. ... ... ... one-half 

B ... ... one-third 

C. ... ... ... ... one-sixth 

The assets are being realised gradually, and distribu- 
tions are made of the following sums to the partners : — 

1912. £ 

Mar. 31 3,000 

June 30 2,100 

Sept. 30 1,800 

and there are further assets unrealised. 

Of the three partners, B. has contributed Capital in 
greater proportion than either A. or C, having regard 
to their respective shares in the profits. C, with one- 
sixth share, has contributed more largely than A., with 
one-half interest. 

The first payment of ^3,000 will therefore be divided, 
as to B., ^'1,800 (so as to bring his balance in propor- 
tion to the Capital of C), and a further ;^8oo to B. and 
;{^40o to C. (so as to exhaust the whole ;£,'3,ooo). It will 
be noted that A., being still below his full proportion 
of Capital, has received nothing. 

Out of the second payment of ;^2,ioo, prior payments 
of ;6'6oo to B. and /;3oo to C. will reduce their respective 
Capital Accounts to sums which are in due proportion 
to the original capital of A.; and the balance of the 
£2,100, namely ,^,'1,200, will then be divided amongst 
all the partners in due proportion. The third payment 
of ;i;i,8oo calls for no special comment, for it will be 



114 



PARTNERSHIP ACCOUNTS. 



distributable pro rata amongst the partners, as shown 
in the following table : — 



Capital as per Balance Sheet . . 
First Distributio J 



First Distribution 
Second Distribution 
Second Distribution 
Third Distribution 



A. 

£ 
3,300 

• • 


B. 

£ 
5,400 
1,800(1) 


c. 

£ 
1,800 

) 




3.303 


3,600 

800(1) 


1,800 

400(1) t 


/;3,ooo (2) 


3,30 J 

• • 


2,800 
600(2) 


1 400 

300(2) j 




3.303 
600(2) 


2,200 
400(2) 


1,100 
200 (2) 


/;2,ioo (2) 


2,700 
yoo(3) 


1,800 

6oD(3) 


900 

300(3) 

£600 


£i,Soo 


£1,000 


;t"l-200 





The reason for this method of making the distribution 
is apparent when the final position is considered. 

Assume the worst, viz., that nothing further is 
realised ; the loss on realisation is then ;i\3,6oo, to be 
apportioned as to — 



A., one half share 
B., one-third ,, 
C, one-sixth ,, 



... jCiySoo 

1,200 

600 



or exactly in the amounts of the balances at credit of 
the respective Capital Accounts. Any less amount of 
loss is capable of similar treatment. 

It is not possible in every case to bring the Capital 
Accounts into these precise proportions by means of 
cash distributions. If A., for example, had to credit on 
31st December 191 1 only £240^ the distributions would 



PARTNERSHIP ACCC-UNTS. 



1 I 



have been insufficient to cancel down the Capitals of the 
other partners to ;{;i6o and ;t'8o respectively ; but, so far 
as is possible, the periodical distributions of cash should 
be made with a view to adjusting the position between 
the partners inter se, so as to leave each partner in credit 
for an adecjuate amount to meet the share of any loss 
upon realisation to be charged against him; or, at any 
rate, to reduce any adjustment necessary to as small 
amounts as possible. 

The method of distribution illustrated can only be 
adopted with complete safety where the partners are 
solvent; otherwise additional loss might accrue to some 
of the partners through the default of another in not 
making good an amount ultimately standing to his 
debit in the books of the firm. (See p. 117.) 



As the amount due from each partner as his share 
of the loss of the firm depends on tlie result of the 
realisation, the amount ultimately due on balance to or 
from any one partner cannot be ascertained until tiie 
realisation is completed, and this latter amount (if a 
debit and one which the partner concerned cannot 
liquidate) cannot be apportioned between the other 
partners prior to that time. Where, therefore, it is 
possible that such a loss may accrue to some of the 
partners from this cause, there should always be with- 
held from the interim distributions a sum sufficient to 
make any necessar}^ adjustment. 

From the general theory of Partnership Accounts as 

illustrated throughout this work, it is clear that any 

I 2 



ii6 



PARTNERSHII* A( COL NTS. 



amount by which the surplus of assets over HabiHties 
(including sums due to partners for Advances and 
Current Accounts) falls short of the total of the amounts 
due to partners in respect of Capital represents a loss or 
deficiency of Capital. It is then to be made good by 
the partners. If there are undrawn profits due to them 
these shall first be resorted to; if not, the shortage is to 
be made good out of Capital ; next, by the partners 
individually, in the proportions in which they are 
entitled to share profits. Section 44 says " shall be paid 
by the partners," but, in practice, this is usually inter- 
preted to mean " shall be brought into account " (or 
debited) against the partners. 

The following Balance Sheet, as at 31st December 
1912, is submitted in illustration : — 



Liiibiliiies 

Capital Accounts — 

*A. (i) due to him . . £2,000 

B. (|) , .. I, too 

C. (|) , . . 800 



£ s d 



Current Accounts, as at 31st 

December igii — 

A. due to him . . . . £400 

H. , .. ., 300 

C. • .. .. icb 



3,fk»o o o 



800 o o 



£ 4,600 o o 



Aiscts 

Cash, after paying Creditors 
Dniwings Accounts (1912) — 

A £4CO 

B 240 

C 240 

Deficiency of the firm 



£ s d 

3,120 o o 



880 o o 
600 o o 



4.foo o o 



♦ The tractions in parentheses denote the shares in profits. 

The " deficiency " is a loss or deficiency of Capital, 
and is to be made good (as a debit on Profit and Loss 
Account) by being charged against the partners. Thus : 



PARTNERSHIP ACCOUNTS. 



117 



Liabilities 

A. Capital Account .. £2,000 
Current Account .. 400 



Less— 

Drawings . . £400 
Share of 
Deficiency (%) 300 



2,400 



/ s «1 



A ssets 



Cash 



700 



B. Capital Account .. 1,000 
Current Account .. 300 



1,700 o o 



Less- 



Drawings . . i 240 
Share of 
Deficiency (J) 150 



1,300 



390 



9:0 o o 



C. Capital Account .. 
Current Account .. 



Less- 
Drawings .. £240 
Share of 
Deficiency (J) 150 



800 
100 

900 



390 



£ s d 
3,120 o o 



510 O O |1 



£ 3.120 o o 



£j 3.120 o o 



In connection with Partnersliip Accounts, and more 
particularlv the accounts upon a dissolution and their 
adjustment as regards the partners inter se, there have 
been decided in recent years two cases of more than 
ordinary interest to accountants, known as Garner v, 
Murray (1904, i Ch. 57 ; 3,2 Accountant Law Reports, 3) 
and Elliott v. Klliott (43 Accountant Law Reports, 47). 
Although these cases have been referred to elsewhere, it 
has been thought desirable to give them separate and 
distinctive consideration. 

The rule in Garner v. Murray. — 

Prior to the decision in this case, it had been the 
practice to interpret the phrase " losses, including losses 
and deficiencies of capital," as inclusive not only of the 






Ii8 



PARTNKRSH IP ACCOL NTS. 



losses arising from the trading operations of the partner- 
ship as a whole, but also of the loss accruing to some 
of the partners from the default of another in making 
good the amount due from him by way of contribution 
towards trading losses. 

The position of affairs in Garner v. Murray was 
approximately as follows : — 



Capital Account 



Gamer 
Miirrav 



fS0 


s d 


2,500 





3M 




I 


2,814 


1 







A ssi-Zs 

Cash 

Wilkins (overdrawn) 

Deficiency of Finn . 



£■263 ; 
635 ' 



£ s d 

1,916 o o 

898 o o 

£ 2,814 o o 



It appeared that Wilkins was unable to contribute 
anything. The agreement between the partners was to 
the effect that profits and losses of the partnership were 
to be shared equally, but there was no special agreement 
as to the treatment, as between Garner and Murray, of 
the loss to them through the insolvency of Wilkins. 

The generally accepted method of adjustment prior to 
the case of Garner v. Murray was to treat the deficiency 
of the firm and Wilkins' irrecoverable debt as partner- 
ship losses, and to write them oft" against Garner and 
Murray in the same relative proportions as they had 
previously participated in profits, thus : — 



Capilul Account 

Garner, Capital Account £2,^00 
Le 5 Half-share of £898' 449 



£ s d 



2,051 o o 



£ 2,051 o o 



Asstts 

Cash 

Murray— 

Half-share of £898 /"44g 
/,€"$$ Capital Ace junt 314 



£ s d 

r,yi6 o o 

135 o o 

£ 2,051 o o 



PAUTXKUSHIP ACCOUNTS. 



119 



The result would be to leave Murray indebted to 
Garner for ;6'i35» while Garner would receive this 
amount and take the whole of the partnership cash, 
/:i,9i6. 

It was, however, held by Mr. Justice Joyce that the 
loss sustained by some of the partners by reason of the 
default of another in respect of a balance appearing due 
from him as regards the partners inter se, must be 
distinguished from a loss of the firm as a whole; that it 
was not to be treated in the same manner as a trading 
loss or loss on realisation ; that it was not, therefore, to 
be made good by the non-defaulting partners in the ratio 
of their shares in ordinary losses, but to be treated as a 
loss to be borne by tiiem rateably according to the 
amounts due to them in respect of Capital, due account 
beiniT taken of the contributions due from each partner 
in respect of any deficiency of Capital otherwise arising. 

Paragraph (a) of Section 44 refers, therefore, to losses 
of the firm as a whole, and not to losses of some only of 
the partners. Losses of the firm as a whole must be 
borne by all the partners, but a loss caused by the 
default of one of the partners ex necessitate rei cannot be 
borne by that partner. It is a loss which falls on the 
remaining partners, but not one in respect of which 
thev have to make contribution. 

The eft'ect of the decision is, that a loss of the kind 
stated is to be borne by the non-defaulting partners in 



* 



I20 



PARTNERSHIP ACCOUNTS. 



the proportions of their Capitals. The true adjustment 
would therefore be as follows : — 



Balaxc-e Sheet. 



Capital Aicounls 



Garner 
Murray 



£ s d : 

2,500 O O I 
314 o O 



£ 2,814 o o 



A ssets 

I £ s d 

Cash 1,9:6 o o 

Garner's contribution to his ' 
deficiency of Capital, one- 
third of £6^5 .. .. ' 212 o o 
Murray do 212 o o 



Wilkins, overdrawn .. jf263 j 
One third of deficiency 211 



2,340 o o 



474 o o 



£ 2.814 o o 



Adjust-mext. 



Gamer— 

i2?S of £2,340 =. £2,078 

Less contribution due 212 



Murray— 
iJ^A of £2,340 = £262 

Less contribution due 212 



€ s d 



1,866 o o 



50 o o 

■ 

£\ 1,916 o o 



Cash 



£ s d 

1. 916 o o 



£ 1,916 o o 



It has been suggested that Garner and Murray miglii 
claim as a set-off the amount due from them in contribu- 
tion towards the deficiency of the firm's Capital; in 
other words, that the cash, ^.'1,916, be divided in the 
proportions of Garner £2^288 (;£;2,500 less .;£,'2 1 2) and 
Murray £102 {£314 less ^,'212). It is submitted that 
the amounts of £2^288 and ;£,'i02 were not the amounts 
of the respective shares in Capital of the solvent 
partners at the time of the default of Wilkins, but 
that these were ;^2,5oo and £314 respectively, and 
that the true bases of apportionment are the amounts 



PARTNERSHIP ACCOUNTS. 



121 



of Capital after due contribution of any deficiency 
thereof, not the amounts of Capital as diminished by 
the deficiency. 

It is entirely within the powers of the partners to 
adjust their contributions of Capital from time to 
time. They may do so at the date of each annual 
Balance Sheet, and the adjustment may be by transfer 
of any profit or loss to the respective Capital Accounts 
of the partners in the proportions in which they are 
entitled thereto or chargeable therewith. It is often 
found that losses and excesses of withdrawals over 
profits are so transferred, instead of being paid in by 
the partners; while, similarly, any excesses of profits 
over withdrawals are likewise carried to the credit of 
the Capital Accounts. Thus, in the accounts of many 
partnerships, Capital is a fluctuating quantity, and the 
original sums agreed upon soon lose their identity. 

In order that the new balances of the Capital Accounts 
{adjusted in the manner stated) may be regarded as 
Capital, there must be some agreement so to regard 
them. Possibly a periodical Balance Sheet, signed by 
the partners, may amount to a fresh agreement. 

Upon the facts of Garner v. Murray, the agreed 
Capitals were : Garner ;^2,500, ^lurray £314, and the 
•deficiency of firm's Capital (;^'635) arose since these were 
agreed. Wilkins' default in respect of ;^474 was there- 
fore to be apportioned upon the basis of the shares in 
Capital, without regard to the deficiency of Capital. 



122 



PAKTNKKSm I» ACCOUNTS. 



The contributions due from Garner and Murray 
would not (in this particular case, namely, a dissolution) 
be paid in in cash, but be brought into account against 
them, i.e., treated as an addition to the available asset 
of cash. 

Having regard to the facts that (i) advances rank 
in priority to Capital upon a dissolution; (2) that 
partners are liable to contribute, in fact or in account, 
ordinary deficiencies of Capital ; (3) that any loss caused 
by the default of a partner in satisfying the amount 
due from him in respect of overdrawn Capital and/or 
contribution towards deficiencies of Capital is to be 
borne by the remaining partners in the proportions of 
their Capitals ; the exact terms of the agreement between 
the partners as to their respective shares in Capital and 
claims for advances are of great importance. 

Following the rule laid down in Garner v. Murray, 
if the following were the final position on a dissolution 
of a firm consisting of three partners, namelv : — 



X. Capital Account 



£ s 

702 o 



d 

o Cash 

V. (overdrawn) 
I Z. ( do. ) 



£702 o o 



£ s d 

351 o o 

"7 o o 

234 o o 

£'702 o o 



A. would take the cash £:^^i, and whatever he could 
get from Y. and Z., but neither of the partners in debit 
would be liable to pay up more than the amount 
appearing due from him above, even though one of 
them was unable to pay to X. the whole or even part 
of the amount due from him. 



PARTXERSHIP ACCOrXTS. 



123 



Elliott V. Elliott. — 

In this case, the firm originally consisted of four 
partners, A., B., C, and D., sharing profits and losses 
in the following proportions : — 

A 

A. M. » •■• «•• ••• 

M ^ m ■«« ••• •■• 

c 

^^. • ••• ••• ••• 

M.^ • ••• ••• ••• 



four-elevenths. 

three 

two 

two 



>> 



ji 



>» 



The articles of partnership provided that on the death 
of a partner his interest in the partnership, including his 
share of the goodwill, should, as and from the date of 
his death, be purchased by the remaining partners in 
tiie proportions of their respective shares in profits, and 
that they should execute a joint and several bond to 
secure payment of the amount due, payment to be made 
by eight half-yearly instalments. 

The partner B. died in 1906. The amount then 
ascertained to be due in respect of his interest was passed 
to the credit of his executors. It was treated as a 
liability of the firm, and appeared as such in the firm's 
Balance Sheets. 

From time to time the firm (A., C, and D.) made 
payments on account of the amount due to B.'s 
executors. 



In September 1910 A. died. The liability to B.'s 
executors had not then been fully discharged, as the 
amount (for reasons which will appear) was large, and 
the time for payment had been extended. 



124 



PAUTNERSHIP AC COL NTS. 



PARTNKRSIIIP ACCOINTS. 



In the lialance Slieet of the firm prepared as at the 
date of A.'s death, loth September 1910, a habihtv 
appeared towards B.'s executors of the balance due. 

The executors of A. then brought an action to deter- 
mine whether the debt due to B.'s estate was properly 
to be treated as a debt due from the partnership of A., 
C, and D. 

It was held that the debt was not a partnership debt, 
but one due in proportionate shares from A., C, and D. 
individually. It apparently did not affect the matter 
that the firm's cheques had been used to pay out the 
share due to B., that B.'s executors had taken these 
cheques, or that an account for B.'s executors still 
appeared in the books of the firm. 

The decision has been questioned on the ground that 
the facts of the case showed an agreement between B.'s 
executors and the firm to regard the liability as a debt 
of the firm, and that the whole course of dealing 
supported this view. 

The correct treatment (in accordance with the decision) 
would have been, upon B.'s death, to eliminate his 
account from the books by transfer of the balance at 
his credit to the credit of A., C, and D. in the proper 
shares, thus inflating the capital sums at the credit of 
A., C, and D. to the extent of their respective shares of 
the undisclosed liability to B.'s executors from time to 
time. The amounts paid on account (although coming 
from the firm) should have been treated as drawings by 
the partners and charged proportionately to tlieir 
accounts. 



125 



It is obvious that the method of treatment here 
approved may have important effects in determining the 
solvency or insolvency of the joint estate and the rights 
of joint and separate creditors in the event of the 
bankruptcy of the firm or one of the partners. 

TIi^ following Balance Sheets were submitted by a 
correspondent to The Accountant (191 1) in general 
illustration of the positions which did arise and which 
might have arisen : — 

Balance Sheet prepared on death of A. for submission 
to his executors : — 



To Creditors 

„ Bank 

, B "s executors— Balancp re- 
maining due for purchase 
of his share 

„ Capital — 

C. £4-105 2 i 

D. 1064 o 4 



£ s 

5.422 8 
t02 12 



2, ICO O O 



5.169 2 5 



£13.294 3 5 



By Debfors .. 

„ Sicck-in-Trade . . 

„ Cash 

„ Machinery 

„ Goodwill . . 

„ Cap'tal overdrawn 

A 



£ 


s 


d 


6,091 


12 


6 


5,«26 


I 


10 


126 


9 


I 


250 








800 









200 o o 



£ 13.294 3 5 



Balance Sheet as amended in accordance with the 
ruling of Mr. justice Warrington : — 



To Creditors 
„ Bank 
„ Capital — 

A. 

C. 

D. 



£850 o 
4,630 2 I 
1,589 o 4 



£ s 

5,422 8 

602 12 



7.069 



By 



£ 13.094 3 5 



Debtors . . 
Stock-in-Trade 
Cash 

Machinery 
Goodwill . . 



£ s d 

6,091 12 6 

5,826 I 10 

126 9 I 

250 o o 

800 o 



13.094 3 5 



In the second Ikilance Sheet the amount (balance) 
due to B.'s executors has been transferred to the credit 



126 



l».\RTN :£I< SH 1 1» ACCO I N IS. 



of A. (i), C. (l)y and D. (J), in the proportionate shares,, 
and represents their proportions of a private debt due 
trom them individually. 

Supposing, however, that the position on the date of 
A.'s death was as follows : — 

Hat.axce Sheet. * 



To Creditors 

„ Loans 

» BanV 

, B's Executors, balance re- 
maining due, for pur- 
chase of his share 

« Capital : 

Vxia •• •> •• *" 

£ 



;,t22 8 


d 

6 


5.500 
602 12 



6 


2,100 





105 2 


I 


13730 3 


I 



By Debtors 
» Stock-in-Trade . . 
„ Cash 
„ Machinery 
, Goodwill . . 
, Capital overdrawn : 
A. .. £200 o 



£ s d 

6,091 iz 6 

5,826 I 10 

126 9 I 

250 o o 

800 o 



D. 



435 19 8 



635 19 8 

I 

£13.730 3 I 



In these circumstances, the executors of A. might, 
prior to the decision in Elliott v, Elliott, have applied 
to the Court to appoint a receiver, on the ground of 
insolvency, in order to free A.'s estate from liability 
for debts of the firm existing at the date of A.'s death. 
The Balance Sheet, as amended, however, would be : — 



To Creditors 


£ s d] 

5.4^2 8 6 

5,500 

C02 12 6 

i 
1 

1,569 2 5 


By Debtors 

, Stock-in-Tra<le . . 

, Cash 

, >1achinery 

„ Goodwill 

£ 


£ s d 
6,091 12 6 
5,8-6 I 10 


Bank 


i;6 9 I 


« Capital : 
A. .. 

C. .. 

D. V. 


.. £"850 

.. 630 2 1 

89 4 


250 
800 




£ 






• 3.094 3 5 


13.094 3 5 









The firm being solvent, the executors of A. could 
not apply to the Court for the appointment of a receiver 



on the ground of insolvency. 



PARTNERSHIP ACCOUNTS. 



127 



It is convenient to quote here the remarks of the 
Judge with reference to another item in the claim, 
namely, whether, for the purpose of ascertaining the 
share of a deceased partner in the assets of the 
firm, the sum by which he had overdrawn profits 
should be treated as a debt due to the firm, Mr. 
Justice Warrington ruling: "I think there can be 
" no question that Stephen Elliott's estate is now 
*' bound to refund. In now ascertaining the value of 
" the assets for the purpose of finding what is due to 
" him, you must take into account the amount by which 
*' he has overdrawn profits as an asset to the firm.'* 

In regard to the two Balance Sheets last given, some 
reference may be made to the valuation of the asset 
Goodwill at the amount of ,^'800, for the case illustrates 
a difficulty that may sometimes arise. 

It appeared, from the facts that in the first partnership 
of A., B., C, and D. it had been agreed that, for the 
purpose of ascertaining the amount due to the repre- 
sentatives of a deceased partner. Goodwill should be 
taken as of the value of ;^ 10,000. Upon the death of B., 
when effect came to be given to the partnership agree- 
ment, it appeared that ;^ 10,000 was a gross over- 
valuation, but, of course, binding as regards B. With 
a view to adjusting the position for the future, the value 
of the asset was reduced in the new partnership of 
A., C, and D. to ;{,'8oo. 

The overvaluation of ;^9,20o would affect all the 
surviving partners. 



W 



128 



PARTNERSHIP ACCOUNTS. 



This may be illustrated as follows : — 

The shares in profits were — A., four-elevenths. 



B., three 
C, two 
D., two 






B.'s share of Goodwill (;i,'io,ooo) is consequently 
£^u^l 5s. 5cl.» to be charged to the remaining partners 
in the proportions of their respective shares, as follows : 



A., four-eighths (J) 
C, two- „ (J) 
D., two- „ (1) 



;^I,363 12 9 

68i i6 4 
68i i6 4 



(It has been assumed that the partners continue to 
share in the same respective proportions xnier se as 
previously.) 

Upon the death of any one of the partners, A., C, and 
D., the account of the deceased partner will be credited, 
under the terms of the second agreement, with his share 
of the asset Goodwill in the new partnership, which it 
has been agreed should be taken as of the total value 
of jCSoo. 

The facts of the case illustrate the difficulties that may 
arise from the valuation of Goodwill on any hard and 
fast basis, that is, without some relation to current 
profits. 




CHAPTER IX. 



INCOME TAX. 



The profits of a partnership are income of the 
partners and as such are liable to tax, unless the 
individual members of the firm can show adequate 
grounds for exemption. 

The profits will be assessed through the firm, which 
will be regarded as a unit for purposes of assessment 
and collection of tax so far as concerns the income 
derived by the partners from the firm of which they are 
members. 

Under the operation of the Acts, rules, and regula- 
tions relating to income-tax, any amount in the nature 
of income is prima facie assessable upon the total 
amount thereof at the full rate of tax current, unless the 
person entitled to the income can show by proper 
evidence, supported by a claim in due form, that, by 
reason of the nature of the income or the total amount 
of his income from all sources, he is entitled to be 
assessed at a lower rate or upon a lesser figure. 

These are concessions made to individuals, and in 
the consideration of income-tax as affecting partnerships 
it is necessary, therefore, to deal not only with the 
method of preparation of the firm's return, but also with 

K 



I30 



PARTNERSHIP ACCOUNTS. 



those of the partners themselves, as these latter may 
affect the amount and rate of tax to which the firm may 
be assessed in respect of an individual partner's share 
in the profits. 

It is unnecessary to consider here the principles, 
methods, and machinery of income-tax administration, 
except so far as they are concerned with income-tax in 
relation to partnerships. It may briefly be stated that, 
for purposes of assessment and collection, income is 
classified under five Schedules, A to E, of which A and 
D are likely to concern the profits of partnerships. 

Schedule A will affect all propert}' owned by a 
partnership in the form of land and buildings. The 
assessment upon the income value of such property will 
be in every case upon the occupier. Where the occupier 
is not the owner, he will (as authorised by statute) throw 
the burden of the tax upon the landlord by deduction of 
the amount paid from the next payment of rent made 
by him. Where the occupier is himself the owner, the 
incidence of the tax is direct upon the person in enjov- 
ment of the benefits of ownership. Where tlie premises 
are owned by a partnership and are occupied bv the 
firm for the purposes of the partnership business, the 
occupier will still be assessed, but in this case no 
distinctive income— distinguishable, that is, from the 
general profits of the firm— will be received in the form 
of rent, and the amount assessed under Schedule A 
will to that extent be an assessment upon the profits 
of the firm. It should therefore be brought into account 
as a deduction in assessing the latter under Schedule D. 



PARTNERSHIP ACCOUNTS. 



131 



All persons and firms who are believed to be liable to 
income-tax will receive forms upon which to render 
their returns. In the case of partnerships the return 
must include : — * 

(i) A statement of profits liable to taxation. 

(2) A claim for an allowance (if any) for wear and 

tear of plant. 

(3) Particulars of each partner's share in the profits, 

stating whether an "acting" or "sleeping" 
partner. 

(4) Particulars of all annuities, interest on loans, 

patent royalties, and other similar annual charges 
paid by the firm and constituting income of other 
parties. 



Under the Finance Act, 1907, a distinction is drawn 
between earned and unearned incomes, and a concession 
in the rate of tax upon the former is granted, subject 
to proper claims being made by the individual taxpayers 
assessed. Under existing provisions, the full rate of 
tax is IS. 2d. in the £, with power to claim relief in 
respect of earned income where the total income from 
all sources does not exceed ;^3,ooo. Where the total 
income does not exceed ;^2,ooo, the relief is by way of 
assessment upon the earned portion thereof at gd. in the 
£, and w^here it is betw^een ;^2,ooo and ;^3,ooo, such 
earned portion is to be assessed at is. in the £, 

This concession is dependent upon a claim being 

made in proper form, and it is provided by statute 

K 2 



132 



PARTNERSHIP ACCOUNTS. 



that it must be made at the time of making the return, 
and in any case before the 30th day of September in the 
year of assessment. 

The firm's return concerns the partnership, but the 
claims in respect of earned income, &c., are matters for 
the individual partners. They are enabled to make their 
respective claims upon their forms of return, usually 
delivered with the firm's return at the place of business 
of the partnership. In such returns the partners must 
submit : — 

(i) A statement of taxable income (Le.y in addition to 
the amount of partnership profits disclosed in 
the firm's return as accruing to the individual 
partners). 

They may also submit — 

(2) A statement of total income from all sources. 

(3) Claim for exemption or abatement (if any) and 
differentiation in respect of earned income (if 
permissible). 

(4) Claim in respect of life assurance premiums 

(permitted up to one-sixth of total income). 

(5) Claim for allowance in respect of children under 

the age of 16 at the commencement of the vear 
of assessment at the rate of ;^io per child, where 
the total income does not exceed ;£^500. 

Of the claims or allowances here referred to, those for 
exemption or abatement, for life insurance premiums, 
and in respect of children, can be made after tax has 



PARTNERSHIP ACCOUNTS. 



133 



been paid upon the total income, subject to a limit of 
three vears from the end of the year of assessment to 
which the claim relates. 

It has already been pointed out, however, that a claim 
for differentiation in respect of earned income must be 
made before the 30th September in the year of assess- 
ment. The ** earned income" referred to will not be 
assessed until after that date, and, where a claim has 
been duly made prior to the assessment being fixed, 
it can be taxed at the proper rate in respect of each 
partner's share in the profits. If the partners (or any 
of them) make no claim to be assessed at the '* earned 
income " rate, the profits accruing to those partners will 
be assessed upon and through the firm at the full rate. 
Assuming that they do make claims, these can only be 
considered with reference to the total of each partner's 
income from all sources. A statement of this total 
must, therefore, be furnished. Upon this statement 
the other claims mentioned (exemption, abatement, 
deduction of life assurance premiums, and in respect of 
children) are also dependent. The convenient course, 
therefore, where the partners make claims in respect of 
earned income, is for them (having each rendered a 
statement of income from all sources) to make at the 
same time any other claims to which they may severally 
be entitled. 

The claims so made will, if allowed, be brought into 
account by deductions from the firm's total assessable 
profits, as returned by the precedent acting partner. 



' 



134 



PARTNERSHIP ACCOUNTS. 



PARTXKRSHTP ACCOVXTS. 



»35 



It should be clearly understood that, failing any claim 
by any of the partners entitled, the profits of the firm 
accruing to each partner will be assessed to the full rate 
of tax. Before passing from this branch of the subject, 
it may be noted that " earned income " accruing to an 
active partner will be held to include interest on that 
partner's Capital and salary (if any) in addition to his 
share in net profits. 

The return on behalf of the firm will, when filled in, 
be sent to the Assessors of Taxes. In the ordinary 
course, the assessment will be made by the General 
Commissioners, called for this purpose Additional 
Commissioners, with the assistance of the Surveyors of 
Taxes. 

The General Commissioners are local gentlemen, 
possibly competitors in trade of the taxpayer or firm, 
and for this or other reasons it is sometimes preferred 
to mark the return "For Special Assessment," when 
the assessment will be made by the Government ofiicials 
known as the vSpecial Commissioners. 

The profits of a firm for income-tax purposes are not 
the income of any particular year, nor an average of 
profits as divided between the partners, but a statutory 
income, based upon the average of the three years com- 
pleted next prior to the commencement of the year of 
assessment and computed according to the provisions of 
the Acts relating to income-tax. It is proposed first to 
illustrate the manner of arriving at the amount assess- 
able, and then to deal with the general principles upon 
which the adjustments have been made. 






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136 



PARTNERSHIP ACCOUNTS. 



Y. 
Z. 



The following notes are submitted in explanation of 
the accounts and statement given. 

The Balances (A) are those dealt with by the partners 
as net profits divisible according to the partnership 
agreement, as follows : — 

... one-half 
... one-third 
one-sixth 

But all the charges made against the profits in arriving 
at the net figures (A) are not recognised as fair and 
proper charges in arriving at assessable profits accord- 
ing to the Acts, rules, and regulations relating to 
income-tax. Various adjustments are, therefore, made, 
resulting in the amounts marked (B). 

Further adjustments in respect of Partners* Salaries 
and Interest on Capital, which are appropriations of, 
and not charges against, profits, give the amounts 
marked (C). The average of these amounts represents 
the profits oj the firm for purposes of income-tax, 
subject only to the allowance for wear and tear of 
plant. The distinction between (B) and (C) is that the 
former represents profits (as adjusted for purposes of 
income-tax) which fall proportionately to the partners 
under the terms of the partnership agreement, whereas 
the latter includes amounts attributable specifically to 
the partners concerned. This distinction is of importance 
in determining the liability of the individual partners 
and will be considered further. The average of the 
amounts (C) will be the figure upon wliich, subject to 
the alK)wance for wear and tear, the firm will hear tax. 



i 



PARTNERSHIP ACCOUNTS. 



137 



There will, however, be added for purposes of collection 
of tax. Ground Rent and Mortgage Interest, ;^50. 
Following the principle of taxation at the source, the 
Revenue authorities look to the persons charged with 
' the payment of such sums as responsible for the tax. 
They are, in effect, regarded as collectors for the 
Revenue. The firm will not, however, bear the tax, 
but, having already deducted it on payment of the 
Ground Rent and ^Mortgage Interest, will merely pay 
over a sum already in hand. 

In computing the firm's liability, allowance will have 
to be made for the amount already assessed under 
Schedule A, and for the deduction permitted in respect 
of wear and tear of plant. 

The former has already been considered. It has been 
pointed out that the partners' interest in the profits, 
including the benefit arising from occupation of the 
premises, is represented by the amounts (C). The 
premises produce no rent as such. The profits are 
larger by reason that no rent is charged. The Income 
Tax Commissioners, however, assess all premises, and 
the assessment under Schedule A is in this case, there- 
fore, merely upon a part of the profits. Consequently, 
the balance of profits only remains for assessment. 



\i 



In arriving at the amounts marked (B), the amount 
already charged for Depreciation of Plant has been 
added, inasmuch as the allowance for Wear and Tear is 



138 



PARTNERSHIP ACrorNTS. 



an allowance to be made by the Commissioners in fixing 
the assessment. The allowance so made is a fair deduc- 
tion in calculating the incomes of the partners for 
purposes of abatement, &c. 

In arriving at the average for assessment, the firm is 
entitled to deduct any sums entering into (A), which, 
being in the nature of income, such as Rents and 
Dividends, have been taxed prior to receipt. 



From the foregoing statement it has been established 
that the liability of the firm in respect of income-tax is 
upon ;{^2,597, which will be set out upon page 2 of 
the firm's return. It will also be shown upon page 4 
of such return that they have paid away /;5o for Ground 
Rent and Mortgage Interest. 

The average as adjusted will be set out in the firm's 
return as follows : — 

Page 2. 

Statement of I'ntaxed Income for assessment under Schedule D 
from trade, profession, employment, or vocation, viz. :— 

The trade, profession or business of 

carried on by X., Y., and Z. 

^^ £^,^^7 

Less amount claimed for wear and tear of 
machinery and plant, and not deducted in 
arriving at the above figures 220 



Net ... 



— ;^2,597 



(It is presumed that the amount claimed for wear and tear 
is that eventually allowed.) 






PARTNERSHIP ACCOUNTS. 



139 



Page 4. 
3. Particulars of all annuities, interest on loans, patent royalties, 
and other annual charges (excluding life assurance premiums), 
payable out of the profits or gains. 



Persons to whom payable. 



Name 
John Jones 
Wm. Roberts . . 



Address 

i6iUlverston Road, Windermere (Mortgage 
Interest) r " j " 

18 Se^bank Road, Golder's Green, London, 
N.W. (Ground Rent) 



Amount pay- 
able for the 
Current Year 

I s d 

40 o 

10 o o 



£^0 o o 



4. Particulars of the share of each partner in the total profits of 
the firm, entered on page 2, after deducting the amount of the 
payments under head (3) of this declaration. 



Name of the 
Partners. 



Residences of 
the Partners 



Whether a ' Amount of each 
" Sleeping " or an Partner's share of 
" Acting " Partner! the Profits. 



Basis of Distri- 
bution of Profits 
under Partnership 



Acting 



do. 



do. 



1,573 



733 



441 



5%p.a. on Capital 
= £300, Salary 
/400, and one 
half balance 

5% p. a. on Capital 
= jfso, Salary 
£100, and one- 
third balance 

5% p.a. on Capital 
= £150, and one- 
sixth balance 



£2,747 



The partners have, as individuals, the rights to certain 
abatements and allowances (as already set out). Each 
may claim — 

(i) Exemption, if his income is under ^'160. 
(2) An abatement, varying with the amount of income 
from all sources, if his income from all sources 
does not exceed ^700. 



i! 



I 



140 



PARTNERSHIP ACCOUNTS. 



(3) An allowance, where the income from all sources 

does not exceed ;^5oo, in respect of every child 
under the age of 16 on the first day of the year 
of assessment. 

(4) An allowance in respect of life assurance pre- 

miums, where paid to a company legally estab- 
lished in any British possession or lawfully 
carrying on business in the United Kingdom, 
to an amount not exceeding one-sixth of his 
income. 

(5) Differentiation in rate of tax in respect of earned 
income. 

The method of apportioning the profits among the 
partners and of fixing their right in respect of claims, 
&c., can best be illustrated by reference to the example 
already given. 

Profits of firm of X., V., and Z. as accruing to the partners, aa 
adjusted for purposes of income-tax. 



Division of average of amounts 
marked (B) proportionately ac- 
cording to partnership agree- 
ment 1908-9 . . £1.450 
1909-10 ,. 2,060 
1910-H .. 2,391 

£5i9oi 



X(i) 



Average £1,967 



Partner's Salar'es 
Interest on Capital 



Total (C) £2,967 



Less, Proportions of allowances for 
wear and tear 



983 



400 

300 



Y(i) 
£ 



£ 



636 



100 
50 



Profits of partners 



1,683 



no 



806 



73 



328 

nil 
150 



£1,573 



£713 



478 



37 



£441 



The amount divided is (in total) ;^2,747, which, in 
the example given, is the average of the 

figures (C) ;£'2,967 

Less allowance for wear and tear ... 220 



PARTNERSHIP ACCOUNTS. 



141 



The return on behalf of the firm, the essential 
particulars of which have been stated, will be supple- 
mented by the separate returns of each partner. 

They may, but probably will not (unless it be Bank 
Interest) have untaxed income to declare, and this part 
of the return (page 2) will, therefore, be marked niL 



In order, however, that they may obtain the advantage 
of the abatements and concessions allowed, they will 
fill up page 3 of their returns, with a statement of 
income from all sources, set out under descriptive 
headings, whether tax has been paid thereon or not. 

This will enable them to get the benefit of the claims, 
abatements, and allowances already set out. 

They are not obliged to fill in page 3, but cannot get 
the concessions unless they do so, or otherwise render a 
statement of their income from all sources. In regard 
to '* differentiation,'* in particular, the claim must be 
made before 30th September in the year of assessment 
and at the time of making the return. 

It will be an advantage, as well as a convenience, that 
the claims be made concurrently with the firm's return, 
and this will ordinarily be done. 

The partners will, therefore, on their personal returns, 
show not only untaxed income, but — 

(i) A statement of income from all sources. 

(2) Life assurance premiums paid. 

(3) Particulars regarding children in respect of whom 

a claim is made. ' 



142 



PARTNERSHIP ACCOUNTS. 



For the purposes of illustration, it may be assumed 
that the following particulars have been furnished by 
the partners : — 

I. Total income from all sources, including 
shares in profits of firm, as adjusted, 
and of Interest and Dividends 
received by the firm £3*^02 ;^2,ioo £492 

2. Life Assurance Premiums paid ... £222 ^^8o * ^^90 

3. Children under 16 at commencement of 

year of assessment (/'lo per child) ... — — ^^20 

As the claim in respect of children can only be made 
where the income from all sources does not exceed ;{^500, 
this will concern Z. only, who will consequently obtain 
an allowance of £20 under this head. 

X.'s total income is over ;t'3,ooo, and he consequently 
obtains no concession in respect of his earned income. 
He will claim, however, for the full amount of insurance 
premiums paid, as these do not amount to one-sixth of 
his income. 

Y. is entitled to be assessed at is. in the £ on his 
earned income, as his total income is between ;£'2,ooo 
ancl ^3,000. He also has a claim for insurance 
premiums. 

Z. may claim — 

(i) To be c\ssessed at gd. on his earned income. 

(2) An abatement of ^£,'150, based on the amount of 

his total income. 

(3) An allowance for life insurance premiums, but up 

to one-sixth of his total income only (i.e.y £82), 

(4) An allowance in respect of children. 

Assuming that the partners have filled in all proper 
particulars prior to the making of the assessment upon 



PARTNERSHIP ACCOUNTS. 



143 



the firm's profits, the allowances due to them will be 
made from the firm's assessment, and an assessment 
notice will in due course be issued as under :— 

Amount of Duty 
Assessment, payable. 



Profits of Trade, Profession, Employment, or 
Vocation 

Deduct Amount of Allowances for — 

Abatement ... £^S^ 

Life Assurance 4^5 

Wear and Tear of Machinery and 

Plant 220 

Children • 2° 



2,817 



Net amount chargeable at is. 2d. in the £ 
do. IS. do. 

do. Qd. do. 



875 
;^i.942 

£ 

• i>275 

503 
164 



£ 
74 
25 



s d 

7 6 

3 o 

3 o 



;^i,942 ;^io5 13 6 



The rate of tax for the assessment is calculated as 



follows : — 

Total Profits (C) as adjusted ... 

Add Charges taxed by deduc- 
tion (;^50) 

Less Schedule A ... ;i^2oo 
Wear and tear allow- 
ance 220 



X. 

£ 
1,683 

25 
1,708 



Y. 

£ 

806 

17 
823 



z. 

£ 

478 

8 
486 



;^420 



Less Abatement 

Life Insurance 
Allowance for Children 



210 
1,498 
223 

£^^27S 
at 1/2 



140 
683 
x8o 



£503 
at i/- 



70 



416 



150 
82 

20 

252 



;^i64 
at gd. 



•44 



PARTNERSHIP ACCOl NTS. 



PARTNERSHIP ACCOUNTS. 



The firm will have deducted tax on payment of the 
Ground Rent and iMortgage Interest, but, having 
already paid tax on a larger amount (under Schedule A) 
of unearned income, is allowed to retain the tax deducted 
on the sums paid away. This recoupment being per- 
mitted to the firm, tax is borne by it on unearned income 
^'200 (Schedule A), less ;{;5o. The latter amount, being 
set off against unearned income in this manner, is con- 
sequently added on in the assessment of the firm's 
*' earned ** profits. 

If the Fixed Charges had exceeded the amount of 
unearned income, the firm would have had to account 
for tax on the excess at is. 2d. Thus : — 

Total Profits (adjusted) ^,^^^^ 

Add Mortgage, Interest, Annuities, &c. taxed 
by deduction on payment ^go 



145 



Less Schedule A Assessment 
Tax pa3'^able on ... 



1,900 
200 

£1,700 



Assessed as to ^280 at is. 2d. and as to ;^i,42o at " earned 
income rate," if partners prove themselves so entitled. 

So far as the sums from which tax should be deducted 
exceed unearned income received, they obviouslv repre- 
sent amounts upon which tax has x\o\ yet been accounted 
for. 



The following is the account relating to income-tax 
as it will appear in the firm's Ledger : — 
^''- Income Tax. Cr. 



To Cash, Schedule A Thx . . 
• Dw. do. DTax .. 



jf s d |! 

II 13 4 <: By Mortgage Interest Account 
105 13 6 ,, Ground Rent Account . . 



£ s d 
268 
o II 8 



' 



The method of adjusting the Profit and Loss Accounts 
in arriving at the amount assessable has been illustrated 
and an assessment would have been fairly made accord- 
ing to the income-tax rules and regulations upon the 
figure resulting from the illustration. 

But all assessments are not regarded by taxpayers as 
properly made, and appeals consequently become 
necessary. 

The taxpayer may have failed to make a return ; it 
may be thought that he has made an incorrect return. 
It may be the case that some question of principle is 
involved. The taxpayer may claim a deduction to 
which the Commissioners of Taxes do not consider him 
entitled; the Surveyor may seek to assess some source 
of gain in respect of which the taxpayer disputes 
liability as not being "income" under the proper con- 
struction of the Income Tax Acts. He will then be 
assessed (and this will apply to a firm also) at such 
amount as may be thought to represent his profits. 
From such an assessment an appeal may be made. 

In order to prosecute an appeal, the taxpayer must 
give notice of his intention within ten days of receipt 
of notice of assessment. 

The appeal will ordinarily be to the General Commis- 
sioners and will be heard by them, unless the appellant 
by his notice demands the hearing thereof by the Special 
Commissioners. 

It is of importance to realise the position of the 
appellant. It is for him to dispute the assessment; it 
will stand unless he does so with success. He must 



146 



PARTNERSHIP ACCOUNTS. 



PARTNERSHIP ACCOUNTS. 



therefore submit such evidence as the Commissioners 
may consider adequate to show that the assessment is 
not justified by the facts 

The taxpayer should produce accounts sufficiently 
accurate to show his profits. He may be required to 
produce his books of account and to submit a Balance 
Sheet. This cannot be compelled, but unless the require- 
ments of the Commissioners are complied with, they 
may not be able to see their way to grant relief in the 
amount of the assessment. 

An excessive assessment and the consequent appeal 
frequently reveal the fact that the firm's accounts have 
been kept in an unsatisfactory manner. The Commis- 
sioners then, speaking generally, give a fair measure of 
latitude, and seek to arrive by approximation at a rough 
estimate of results, even though the accounts are not 
such as a professional accountant could properly certify. 

The following case is of interest : — 

A. was in partnership with his son B. as motor-car 
dealers and engineers. They shared profits and losses 
in the proportions of two-thirds and one-third respec- 
tively. They kept no proper books of account, but had 
drawn steadily since they commenced in partnership on 
I St January 1907, at the rate of, A. £:^, and B. £2 per 
week. They made no returns, and were assessed in 
successive years as follows : — 

Year 1906-7 (three months) ... ;^50 



1907-8 ... 
1908-9 ... 
1909-10 
1910-11 
1911-12 
and for 191 2-13 at 






>> 



»> 



>> 



150 
200 

250 

300 

500 

1,000 



147 



/I 



They appealed (for the first time) from the 191 2-13 
assessment, and it then became necessary to submit 
accounts for the years 1909, 1910, and 191 1. This 
it was not found possible to do, but Messrs. A. and 
B., with the assistance of an accountant, prepared a 
Balance Sheet as at 31st December 191 1, disclosing a 
surplus of assets over liabilities other than Capital at 
that date of ;^i,88o. The following statement was then 
prepared : — 



Surplus as at 31st December 191 1 ... 
Add Drawings 1907-8-9-10-11 — 

A. £15^ per annum 

B. ;^io4 do. 



;^i,88o 



£7^0 
520 



Less Capital paid in ist January 1909... ;^i, 600 
do. 31st July 1910 ... 600 



1,300 

- 

3,180 



2,200 



Balance of Profits accrued over five years... ;^98o 

The average for five years was shown to be consider- 
ably less than the assessment of ;^ 1,000. The Surveyor 
contended, however, that the above statement should not 
be accepted in reduction of the assessment, as the two 
earlier years might have resulted in losses of (say) 
;^2,020, and the three years, 1909-10-11, upon which the 
assessment was based, have shown profits of (say) 
^3,000, leaving ;^98o profit on balance. 

This further contention was met by a comparative 

statement of turnover for the various years (particulars 

for the preparation of which existed) and by a 

^calculation of gross profits thereon ; which, while only 

L 2 






148 



PARTXEKSHIP ACCOUNTS. 



approximate, were sufficient to show that there had been 
no such great improvement in the last three years as to 
justify the Surveyor's contention. In the result, the 
assessment was substantially reduced by compromise. 

It is not possible in a work of this nature to carry 
further the consideration of this branch of the subject. 



The assessment of partnership profits is ordinarily 
made upon an average of three years. 

The materials for arriving at an average over this 
period do not exist in the case of a new business, and 
the assessment is consequently made on the results 
available. 

The assessment upon the first year's results naturally 
cannot be made until the conclusion of the year, and is 
then fixed at the amount of the profits actually made. 
There will in this case be no need for an appeal if the 
accounts are accepted as correct, unless in regard to 
some matter of principle. 

When past results are available, the assessment will 
be made in advance. 1 he profits of the first year will 
consequently be adopted as the basis of assessment for 
tlie second year. There will, however, be a right of 
appeal upon the actual profits of the second year. 

The third year will be assessed at the average of the 
first and second years' results, but the taxpayer will 
have a right of appeal upon the profits of the third vear. 



PARTNERSHIP ACCOUNTS. 



149 



These provisions in regard to a new business prevent 
any hardship arising. In the case of improving profits, 
they are a decided advantage to the taxpayer, and, in 
the event of losses and fluctuations, enable him to 
get substantial allowance. 

The operation of these provisions in respect of a new 
business is now illustrated : — 

Three new businesses, termed respectively A., B., and 
C, may be presumed to make profits and losses as 
under : — 





Business A. 


Business B. 


Business C. 


1909 


Profit 


/980 


Profit 


/420 


Loss /loo 


I9I0 


•1 


1,200 


Loss 


50 


80 


IQTI 


i> 


1,450 


Profit 


140 


Profit 800 


I912 


II 


2,000 


It 


560 


„ 1,000 



In respect of these businesses assessments will be as 
follows : — 

JlrV« 



Year 1909-10 
1910-11 

1911-12 



980 



1,200 



1912-13 



980 4- 1,200 + 1.450 



/980 
980 

1,090 
1,210 



Year 1909-10 
1910-11 

1911-12 



No appeals are necessary. 

B. 

/420— no appeal necessary. 
420 — reduced on appeal to nil. 



420 - 50 



1912-13 



420 - 50 -f- 140 



185- 

170 
C, 



do. 



/140 



Year 1909-10 
1910-11 
1911-12 



Nil 
Nil 
Nil 



800- (100 -f- 80) r 

1912-13 5 Z 1 £207 






150 



PARTNERSHIP ACCOUNTS. 



An established business is assessed upon a three 
years* average. It is not necessarily the case that the 
profits in each of those years have accrued to the same 
parties, for it will be assumed that the person or firm 
assessed will succeed to the full benefit of the business 
connection from which the profits are derived. This 
is-known as the *' succession rule," and is based upon 
Section 100 (ist and 2nd Cases, Rule 4) of the Act of 
1842, which is to the following general effect : — 

That if amongst persons engaged in any trade or profession 
in partnership any change shall take place in such partnership, 
either by death or dissolution, as to one or more of the partners, 
or by admission of a new partner ; or if any person shall have 
succeeded to any trade or profession, the duty payable in respect 
of such partnership, or any of such partners, or of the person 
succeeding, shall be computed according to the ordinary rules for 
income-tax assessment, notwithstanding the change or succes- 
sion ; unless it can be shown that the profits have fallen short, or 
will fall short, from some specific cause since the change or 
succession, or by reason thereof. 

The provisions stated give continuity in the basis of 
the assessment and are now illustrated. 

A firm, it may be assumed, consisted, up to 31st 
December 1910, of four partners, sharing as under : — 

Salary. Interest on Share in 

A 

-**• ••* ••• ••• .,, 400 

*•• ... .,, ,,, ... 400 

^. ••« ••• ... ... 3^**^ 

■'-'• ••» ••• ... ... 2^0 



Capital. 

J /o 

cO/ 
J /o 

5% 



balance. 

40% 

35% 
15% 






PARTNERSHIP ACCOUNTS. 



151 



As from 31st December 1910, A. retires. B., C, and 
D. start a new partnership, under fresh agreement, upon 
the following terms : — 



B. 
C. 
D. 



Salary. 

£ 

. 400 

. 360 
. 300 



Interest on 
Capital. 

5% 
5% 
5% 



Share in 
balance. 

55% 

25% 
20% 



The profits, duly adjusted for income-tax purposes, 
have been as follows : — 



1908 
1909 
1910 



Profits. 

£ 
. 4,620 

3,840 
4.750 



Salaries. 

£ 
1.340 
1.340 
1.340 



Interest on 
Capitals. 

£ 
1,200 

1,300 

1,300 



Totals. 

£ 
7,160 

6,480 
7.390 



;^I3,2IO ;^4.020 ;^3.800 ;^2I,030 



The assessment for the year 1911-12 will be upon the 
amount of ;^7,oio, being the average of the three years 
preceding, and will be apportioned in finding the 
liability of the partners, as under : — 



Average Profits . 
Less Salaries — 

iJm • •• • 

V^ • ••■ • 

U* ••• • 



£7>oio 



£^00 
360 
300 



Less Interest on Capital (as for year 191 1)— 

ly » *•• "•• ••• ••• ••• X) ^^^^ 

t^, ... ... ... ... ••• 200 

JJ , ... ... ... ••• ••• 200 



1,060 



5.950 



Amount divisible proportionately ... 



1,000 



;^4.950 



B. 55% 

£ s d 

Proportions of Net Profits 2,722 10 o 

Salaries 400 o o 

Interest on Capital ... 600 o o 



C. 25% 

£ s d 

1,237 10 o 
360 o o 
200 o o 



D. 20% 

r s d 

990 o o 
300 o 
200 o o 



/3,722 10 o ;^i,797 10 0;^i,4Qo o o 



1.52 



PARTXKRSHIP ACaU'NTS. 



PARTNERSHIP ACCOUNTS. 



153 



Upon the figures thus arrived at, the claims of the 
partners for rdief in the rate or amount of tax would be 
deah with. 

The profits of the year 191 1 may fall short of the 
average assessed. This of itself will give no right to an 
adjustment. It is ordinarily a feature in the incidence 
of income-tax that an improving business is assessed 
on less, and a declining business on more, than its 
current profits. But, should the profits fall short from 
a ''specific cause" within the meaning of the section 
of which the effect has been quoted, an adjustment 
will be possible. 

Such " specific cause " may be of varying character, 
but the retirement of a partner (in particular, a senior 
partner) to whose personality and skill the profits have 
been largely due may be "specific cause" within the 
meaning of the section. If " specific cause " is alleged 
and admitted, the assessment will proceed on the same 
lines as for a new business. 

It is important to note the necessity for proof that the 
profits " have fallen short." 

In a case in a practice, a firm who had purchased the 
goodwill of another business were assessed, in default 
of a return, at ;^i,5oo for the year 1912-13. They made 
jCsS^^ only in the year 1912. 

Upon seeking to claim under the "specific cause" 
provisions, on the general ground of the change in the 
ownership of the business, they found that the vendor— 
who had since died-had kept no such books of account 
as would enable accounts to be prepared in manner 



\m^ 



satisfactory to the Commissioners. They were unable 
to show the amount of the profits from which they 
alleged that their own earnings had fallen short, and 
the appeal therefore failed. 

The admission of an employee as a partner does not 
vary the method of assessment. It might conceivably 
be contended that the firm " succeeds " to the employee's 
salary. The assessment, however, will be upon the 
average of the profits divided amongst the partners as 
such. If X., an employee, w^ho has in time past 
received a salary of £soo a year, is admitted a partner 
as at 31st December 1910, the assessment for 1912-13 
will, as usual, be based upon the results of the years 
1909, 1910, and 191 1. The two earlier years are charged 
with X.'s salary. The year 191 1 shows comparatively a 
larger profit, to the extent of the salary not charged in 
that vear. No distinction or adjustment will be made 
on this ground in bringing the earlier years into 
average, and the assessment will be arrived at upon the 
average of the figures of profit divided amongst the 
partners for the time being year by year. 

The ordinary operation of the principle of average 
brings into account losses as well as profits, and, where 
the latter exceed the former in the figures brought into 
account, the full benefit of set-off is obtained. 

A period of profits, followed by a succession of losses, 
may, how^ever, operate to limit the set-off, and, inasmuch 
as the average is arrived at upon the basis of three 
completed (or past) years, the taxpayer may be assessed 
upon some amount at a time when he is actually trading 
at a loss. 



154 



PARTNERSHIP ACCOUNTS. 



It is true that losses come into average, but they 
may be so large as to make the average in future years 
a considerable loss. This will free the individual or 
firm from liability in respect of that particular income- 
tax year, but the full benefit of set-ofT may not have 
been obtained. 

The matter immediately succeeding serves to illustrate 
these points. 

The figures set out may be taken as the profits and 
losses of a firm in successive years : — 











Profits. 


Losses. 










I 


£ 


1907 








... 2,100 




1908 










2,700 


1909 








... 6,600 




I9I0 










3>6oo 


I9II 








... 4,200 




1912 


• • • 1 








600 




;^I2,900 


;^6,900 



Upon these figures assessments will be made as 
under : — 



Income-tax year 1910-11 ... 

do. 1911-12 .. 

do. 1912-13 .., 

do. 1913-14 ■• 



... average ;^2,ooo 

do. 100 

do. 2,400 

do. nil 



Total Assessment ... 



;^4»5oo 



and full advantage of set-off in respect of losses would 
thus be obtained. 



\\ 



PARTNERSHIP ACCOUNTS. 



155 



If the figures be rearranged— as for a declining 
business— the total of the assessments may be much 
greater, thus : — 



1907 
1908 
1909 
1910 
1911 
1912 



'rofits. 


Losses. 


6,600 


I 


4,200 




2,100 


600 




2,700 
3,600 



;^I 2,900 ;^6,900 



The assessments based upon these figures would be : — 

average £^,2po 

do. 1,900 

do. nil 



Income-tax year 1910-11 

do. 1911-12 

do. 1912-13 

do. 1913-M 



do. 



fiil 



Total Assessments 



;^6,200 



The total of the assessments is, therefore, in the one 
case ^4,500, and in the other ;^6,200, although the net 
gain over the six years is the same. This arises from 
the fact that in the latter case the losses have occurred 
in such order as not to give the full benefit of set-off. 

Some relief is afforded by Section 23, Subsections (i) 

and (2), of the Customs and Inland Revenue Act, 1890, 

which is as follows : — 

(i) Where any person shall sustain a loss in any trade, manu- 
facture, adventure, or concern, or profession, employment, or 
vocation carried on by him either solely or in partnership, or in the 
occupation of lands for the purpose of husbandry only, it shall be 
lawful for him, upon giving notice in writing, to the Surveyor of 
Taxes for the district within six months after the year of assess- 
ment, to apply to the Commissioners for the General Purposes of 
the Acts relating to income-tax for an adjustment of his liability 
by reference to the loss and to the aggregate amount of his income 
for that year, estimated according to the several rules and directions 
of the said Acts. 



is6 



PARTNERSHIP ACCOUNTS. 



(2) The said Commissioners shall, on proof to their satisfaction 
of the amount of the loss, and of the payment of income-tax upon 
the aggregate amount of income, give a certificate authorising 
repayment of so much of the sum paid for income-tax as would 
represent the tax upon income equal to the amount of loss, and 
such certificate may extend to give exemption or relief by way of 
abatement in accordance with the provisions of the said Acts. Upon 
the receipt of the certificate the Commissioners of Inland Revenue 
shall cause repayment to be made in conformity therewith. 

The general effect of this section is to enable the tax- 
payer to anticipate the introduction of the loss \ ears 
into average by setting them off against the assessments. 
The losses, or the part thereof so treated, cannot be 
brought into average subsequently. 

Thus, applying a claim under the section quoted to 
the figures last given : — 



Year 1910-11. — Assessment is 

Less Claim upon Loss in year 1910 











lialance taxed 


Year 


1911- 


12.— 


-Assessment 


will be upon — 




1908 


• • • 


• • • • • • 


;^4>2oo 




1909 


• • • 


• • • • • • 


2,100 




1910 


• • • 


• • • • « • 


nil 



;^4»3oo 
600 

;^3.7oo 



;i^6,3oo Average ... ;^2,ioo 

A claim can be made as before in respect of the 
loss in year 1911, or so much thereof as will 
extinguish the assessment 



Balance taxed 
Year 1912-13. — Assessment will be upon — 

1909 ;^2,IOO 

19*0 nil 

1911 loss (adjusted)... foo 



2,100 
nil 



^1,500 Average ... ^"500 



The assessment can again be extinguished by 
bringing into account the loss in 1912 (^3,600) 
so far as necessary 

Balance taxed 



500 
nil 



PARTN KR S H I P ACCC ) I N TS . 



157 



The amounts coming into future averages are there- 
fore : — 



1910 
1911 
IQ12 



nil 
loss 600 
loss 3,100 



By the method of claim illustrated, the final result to 
the taxpayer will be that during the four years he will 
have paid upon ^,'3,700 as against the assessments (if 
made according to the ordinary methods) of ;{^6,200. 

The relief given by this section ^s open to firms as 
well as to individuals, and may be found of substantial 
advantage. 



The additional income-tax known as super-tax is one 
with which partners are concerned only as individuals, 
and for this reason the subject is not dealt with here. 



From the consideration already given to the manner 
of arriving at thfe assessment upon a firm, from the 
circumstance that the profits may be assessed as to parts 
thereof at varying rates, and from the fact that abate- 
ments and concessions in amount and rate of tax due 
to the partners are usually made by way of deductions 
from the firm*s assessment, some care is necessary in 
apportioning the burden of the charge for income-tax 
between the various partners. 



i58 



PARTNERSHIP ACCOUNTS. 



It is clear that the charge is not one to be borne 
proportionately to the partner's share in profits, for 
this might conceivably operate to burden one partner 
with a substantial amount of the tax, when actually 
(by reason of a large contribution being made to his 
co-partner for salary and/or interest on Capital) he 
has been credited (on balance) with no profit whatever in 
that particular year. Various alternative methods have 
been suggested, and it may be best to deal first with 
those which, it is submitted, are inaccurate. For 
example, it is sometimes urged : — 

(i) That each partner should be debited with tax on 
the average of all sums credited to him in respect 
of salary, interest on Capital, and share in profits 
(including his proportion of sums not recognised 
as fair charges for purposes of income-tax) in the 
three years forming the basis of assessment. 

(2) That each partner should be debited with tax upon 
sums to be appropriated from profits in the year 
of assessment for interest on Capital and salary, 
according to the terms of the partnership agree- 
ment for that year, and that the balance of tax 
should be divided in the proportions in which 
profits are shared. 

Neither of these methods can be regarded as satis- 
factory or correct. 

It is submitted that the correct method is to charge 
each partner with the tax upon such part of the firm's 
assessable profits as is attributable to him, whether for 
salary, interest on Capital, or share in profits, in respect 



PARTNERSHIP ACCOUNTS. 



159 



of the year of assessment according to the agreement for 
that year, and to give to each individual partner, in 
apportioning such charge, the benefit of such abatements 
or other concessions as may be allowed to him. The 
method of charge thus follows the method of assessment. 

The illustration given in reference to the '* succession 
rule" (pp. 149-150) may serve further to explain the 
matter. It will be observed that the shares of the 
partners in the profits, and, consequently, in the amount 
of the charge for the income-tax year 191 1 -12, have been 
arrived at according to the partnership agreement as 
fixed for that period, without regard to the terms of 
the agreement as existing for the years forming the 
basis of assessment. 

The tax paid should be apportioned between the 
partners according to the amounts appearing as attribut- 
able to the partners, viz. : — 

£ s d 

B 3»722 10 o 

C 1,797 10 o 

D. 1,490 o o 

and at the rates assessed upon the firm in respect of 
each partner's share, less tax at the same rate upon life 
insurance premiums and other amounts deducted to the 
extent that these may be attributable to the individual 
partners. 

The succeeding illustration shows the method of 
apportionment of the charge for income-tax where a 
change in the basis of apportionment of the profits 
between the partners coincides with a considerable 



1 'I 



.._ J 



i6o 



PARTNERSHIP ACCOUNTS. 



fluctuation in the trading results. For example, in 
successive years, total taxable profits may be assumed 
to have been : — 

•«• ••• ••• Profit 



190S 

1909 

1910 

divided as follows : — 



do. 
do. 



£^^770 

5.970 
<>>57o 



Average ;^5,77o 



A. (1) 

B. (i) 

C. (i) 



1908. 

Salar}'. Interest. Profit. 

£ £ £ 

.. 300 120 1,800 

. 360 90 1,200 

. 300 nil 600 



Total. 

£ 
2,220 

1,650 

900 









£4*770 




1909. 








Salary. Interest. 


Profit. 


Total 


A. (2) 


£ £ 

300 120 


£ 
2,400 


£ 
2,820 


B. (i) ... . 


360 90 


1,600 


2,050 


C. ii) ... 


... 300 nil 


800 


1,100 




;C5.97o 




1910. 


a 






Salary. Interest. 


Profit. 


Total. 


A. (2I ... 


£ £ 

... 300 120 


£ 
2,700 


£ 
3,120 


B. (^) ... 


••• 360 90 


1,800 


2,250 


c. ii) 


... 300 nil 


900 


1,200 



£6*570 

As from 31st December 1910 alterations are made in 
regard to the division of profits and losses. 

The year 1911 results in a loss of ^9,000, which is 
apportioned as follows : — 



B. a) 

c. (i) 



I9II. 


Share of 




Salary. Interest. 


Loss. 


Total 


£ £ 


£ 


£ 


• 300 120 


S^^oj 


4^785 


• 3"0 00 


>,6o3 


2^153 


- 300 240 


2,602 


2,062 



£g,ooo 



PARTNERSHIP ACCOUNTS. 



161 



The assessment for 1912-13 would be based upon the 
average of the following figures : — 



1909 
1910 

1911 



Profit 
do. 


;^5>970 
6,570 


;^i2,54o 
9,000 


Loss 






;^3,S40 



Average ... 



;^i,i8o 



Following the principles laid down, this figure will 
be apportioned amongst the partners on the basis of 
the agreement for the year 1912. Assuming this to be 
the same as for 1911, thus : — 



A. (^) 

B. (i) 
c. (i) 



Salary. 


Interest. 


Share of Loss. 


Total. 


£ 


£ 


£ 


£ 


.. 300 


120 


^^5 


305 


.. 360 


90 


57 loj- 


392 10/. 


.. 300 


240 


57 lol- 


482 10/- 



;^96o £^^Q £230 



;^i,i8o 



the partners would be charged with tax upon the 
amounts in the " Total " column. C, who has had a 
one-sixth interest in each of the three years coming into 
average, is nevertheless charged with one-quarter of the 
loss, according to his share in the year of assessment. 

Under some circumstances, the amount appearing as 
Share of Loss may (for one or more partners) be greater 
than the amounts of Salary and/or Interest credited to 
him or them. Such partner or partners would, accord- 
ing to income-tax rules, have no income from the 
partnership, leaving the firm assessable in respect of 
the remaining partners only. 

M 



l62 



PARTNERSHIP ACCOUNTS. 



For example, A. and B. are partners. A. is credited 
with 5 per cent, on his Capital and shares equally in 
profits with B.; B. has no Capital, and is, therefore, 
credited only with his share in profits, or charged with 
his proportion of loss. 

The profits (average) are ;^2,ooo, prior to charging 
interest, and are apportioned thus: — 

A., for Interest on Capital ... ;^4,ooo 

Less one-half of Loss, ;t2>ooo, 

after charging interest ... i,ooo 

;{^3,ooo credit. 



B. one-half share of Loss 



;^i,ooodebit. 



The assessment upon the firm (;i3,ooo) will concern 
A. only, and the amount paid will be charged to his 
account. 



CHAPTER X. 



ACCOUNTS OF LIMITED PARTNERSHIPS. 



Since the enactment of the Limited Partnerships Act, 
1907, partners are to be classified as active and limited. 
Prior to this statute, it was customary to term a person 
who, while a partner, took no active part in the manage- 
ment of the business as a dormant, or sleeping, partner ; 
but no distinction existed in law as regards liability 
between him and a working, or active, partner. 

The Act of 1907 has not affected the provisions of 
Section 3 of the Partnership Act of 1890, whereby one 
person may lend money to another person or firm under 
a written contract that he should receive a share of 
profits by way of interest. Such a lender would, 
however, be a creditor, and not a partner, of the firm, 
although his claim would be postponed until those of 
other creditors were satisfied. His position of creditor 
would carry none of the rights of a partner. 

Under the Limited Partnerships Act, 1907, it is 

possible for a person to become a limited partner in a 

firm, provided there is at least one general partner. 

M 2 



164 



PARTNERSHIP ACCOUNTS. 



PARTNERSHIP ACCOUNTS. 



lOs 



Every limited partnership must be registered, and no 
person can claim to be a limited partner unless this 
has been done. The particulars for registration must 
include the following: — 

(i) The firm name. 

(2) The general nature of the partnership business. 

(3) The principal place of business. 

(4) The full names of each of the partners. 

(5) The term for which the partnership is entered into 

and the date of its commencement. 

(6) A statement that the partnership is limited, and 

the description of every limited partner as such. 

(7) The sum contributed by each limited partner, and 

whether contributed in cash or how otherwise. 

The limited partner or partners will, at the time of 
entering into the partnership, contribute a sum or sums 
(or property of stated value) as Capital, and he or they 
will^not be liable fprjhe debts or obligations of the 
^^?J^^y^"<^ ^he amounts so contributed ; but the general 
partner or partners will be liable for all debts and 
obligations of the firm. 

A limited partner shall not, during the continuance 
of the partnership, either directly or indirectly, draw out 
or receive back any part of his contribution. (Section 
4 (3), Limited Partnerships Act, 1907.) If he should 
/ do so, he will be liable for the debts and obligations of 
the firm to the extent of the amount withdrawn— in 
addition, of course, to the amount of his Capital remain- 
ing in the firm. 



I 



A limited partner shall not take part in the manage- 
ment of the partnership business, and shall not have 
power to bind the firm ; but he may, by himself or his 
agent, at any time inspect the books of the firm and 
examine into the state and prospects of the business, 
and may advise with the partners thereon. 

It is not necessary to consider the law as affecting 
limited partnerships, except so far as it may appear to 
bear upon the accounts, the chief points for considera- 
tion arising out of the matters already set out. It is 
important to note, however, the provisions of Section 7 
of the Limited Partnerships Act, 1907, which is to the 
effect that, except in so far as expressly varied by the 
Act itself, the Partnership Act, 1890, and the rules of 
equity and of common law applicable to partnerships, 
except so far as they are inconsistent with the last 
mentioned Act, shall apply also to limited partnerships. 

There is nothing in the Limited Partnerships Act 
which necessitates any departure from the ordinary 
method of keeping partnership accounts, but the pro- 
visions quoted imply alteration in the obligations of 
the partners which may affect the positions of the 
partners inter se. 

In a limited partnership, general partners are still 
liable to contribute their respective shares of partnership 
losses, but this does not apply to the limited partners. 
The liability of the latter is limited to the amounts of 
their contributions in respect of Capital, and there is no 
obligation upon them to make good by further contribu- 
tion any sum by which their Capital is diminished 



I 



1 66 



PARTNERSHIP ACCOUNTS. 



PAinXKRSHlP ACCOUxXTS. 



167 



through losses falling upon the partners as a whole. 
So far as limited partners are concerned, such losses 
will merely be charged against them in their current 
accounts. 

General partners are liable for all debts and obliga- 
tions of the firm, and are liable to contribute not only 
their shares of partnership losses, but, in addition, any 
amount by which the partnership Capital falls short of 
the sum required to satisfy creditors. 

lllusl ration. — 

A. is sole general partner, B. and C. are limited 
partners, in the firm of A., B. & C. The following is 
the Balance vSheet as at 31st December 191 2 : — 



Liabilities. 

Sundry Creditors 

Capital Accounts : — 
A. ... ... ... ;i^4,ooo 

13. ... ... ... 1,000 

C. ... ... ... 1,000 



£ 
2,500 



6,000 

;/'8,5oo 



Assets. 

Sundry Assets 

B., Current Account 

C, Current Account 



£ 

5,700 

1,400 
1,400 



;^8,500 



In this case the partnership Capital was originally ; — 

^^ ■ ••• ••• ••• ••• >•• ■■• Tj^ d. • 000 

X.' • ••• ■>•• ■■• ••• ••• ■•■ I bOvJO 

v.' • ••• ■•• ••■ ••• ••• ••■ I* 000 

;^6,000 



A. has maintained his Capital at the agreed figure by 
contributions of the amount of his share of losses. B. 
and C, being under no obligation to do so, and being 
limited in liability to the extent of their shares in 
Capital, have not contributed beyond these amounts. 
They are in debit upon their Current Accounts, but are 
under no obligation to pay in the amounts of these 



debits. Should profits be made, B. and C. will be 
credited upon their Current Accounts with their respec- 
tive shares, and their original contributions in respect 
of Capital may in that way be restored. 

Sliould further losses occur, A. may find himselt 
obliged to make advances to the firm to maintain a 
sufficient working Capital. Should the losses be so 
great as to create debits against B. and C. upon their 
Current Accounts which extinguish the total of the 
original shares in Capital of all the partners, A. may 
find himself obliged to pay in sums to satisfy the debts 
and obligations of the firm, in respect of which his 
liability is unlimited. This may best be explained by 
further illustration in reference to the firm of A., B. & C, 
by assuming that the Balance Sheet at 31st December 
191 2, after A. has paid in his share of ordinary partner- 
ship losses, discloses the following position : — 



Liabilities. 

A., Capital Account 
Sundrv Creditors... 



£ 
4,000 

4.500 



/-8,Soo 



Assets. 

Sundry Assets 

\\., Current Account ;^3,40o 
Less Capital A/c 1,000 

Due from him. . . 

C, Current Account 3,400 

Less Capital A/c 1,000 

Due from him... 



£ 
3,700 



2,400 



2,400 

;^8,soo 



In this case, the assets are insufficient to satisfy the 
liabilities by i:8oo, and A. is liable, therefore, to pay 
in this amount. He will suffer loss, not only of this 
figure, but also of his Capital. In other words, upon 
dissolution of the partnership affairs, the debits against 
B. and C. become losses of A., since there can be no 
subsequent profits to restore the losses of B. and C. 



i68 



PARTNERSHIP ACCOUNTS. 



PARTNERSHIP ACCOUNTS. 



169 



i 



It might conceivably be argued, on behalf of B. and 
C, that (upon the facts as set out in the Balance Sheets) 
they have a right to withdraw profits made subsequent 
to a loss, that is, that they are under no obligation :o 
restore past losses of Capital. Such a contention may 
be disposed of by reference to Section 7 of the Lim:-d 
Partnerships Act, 1907, the effect of which has already 
been quoted, and which provides that, subject to the 
Limited Partnerships Act itself, the Partnership Act, 
1890, is to apply also to limited partnerships. 

It has already been decided that, under the ^atter 
Act, Capital is a fixed contribution, to be varied only 
by agreement. Losses thereof are to be made good by 
contribution, profits may be withdrawn. 

So far as regards a limited partner, he need not 
actually contribute towards a loss. His share mav be 
charged against him, but this does not alter his a^r^^d 
contribution in respect of Capital, and he ma}" not, 
therefore, withdraw any amount whatever while there 
is a balance against him on his Current Account. 

In further reference to the illustration given, where 
there is more than one general partner, their liability 
for contribution to losses will be proportionate. 

In regard to ordinary trading losses, this present> no 
fresh difficulty, but it has been pointed out that, 
inasmuch as general partners are liable for all deots 
and obligations of the firm, they may have to contribute 
(by way of advances) further sums to satisfy these debts 
and obligations beyond their ordinary contribution to 



trading losses, and, upon dissolution of the firm's 
affairs, to bear, as a loss to them only, any debt 
standing against a limited partner. 

The apportionment of a loss to some only of the 
partners, by reason of the failure of the other, or others, 
to pay in what is due from him or them is covered by 
the rule in Garner v, Murray (see Chapter VIII), and 
is therefore to be charged against the remaining partners 
in the proportions of their shares in Capital. 

The contributions from general partners for the 
purpose of satisfying the debts and obligations of the 
firm, over and above their contributions towards trading 
losses, are, therefore, to be made proportionately to 
their shares in Capital. Upon the dissolution of the 
firm's affairs, the loss (if any) falling upon some of the 
partners of the amount of the debit upon a limited 
partner's account (including the amount charged as due 
from him in respect of his share of trading losses) is 
to be dealt with as a loss of Capital, and charged to the 
other partners similarly in the proportions of their 
shares in Capital. 

A limited partner can, of course, make advances to 
the firm, and can claim repayment of such advances 
without regard to the state of his Current Account and 
whether or not his Capital is extinguished by losses. 
That is, the entire extent of his possible loss as a limited 
partner is measured by his contribution in respect of 
Capital. He is under no obligation to make good by 
contribution any loss beyond that amount, and his 
advances (if any) cannot, therefore, be retained by the 
firm for that purpose. 



170 



PAKTNKRSHIP ACCOUNTS. 



A limited partner may, in fact, call upon the firm 
for repayment of his Loan Account, although there is 
a debit on balance of his Current and Capital Accounts, 
and the general partners are just as much liable to 
satisfy the debt due to him as to pay other ol)ligations 
of the lirm. 



II 



m 



On a dissolution the claims of partners for loans and 
advances are postponed until other claims are satisfied. 
In the case of general partners, no repayment of loans 
and advances will be made without reference to the 
position of the partner as a whole towards the firm ; 
Capital, Current Account, and contributions due for 
shares of trading losses all being brought into account 
in finding what is due to the partner on balance. 

A limited partner, however, will always have a claim 
for his Loan Account, inasmuch as the amount by which 
a debit upon his Current Account for his share of 
trading losses exceeds his Capital cannot be set. off 
against it. 

A loan owing to a limited partner may be constituted 
originally by a transfer of some amount standing to his 
credit upon his Current Account and representing 
undrawn profits. The nature of the loan does not vary 
what has been stated. 

A limited partner is not bound to pay in any share 
of losses attributable to him, but he would not be able 
to withdraw any subsequent profits accruing to him 
until such losses had been made good. ' 



PARTNERSHIP ACCOUNTS. 



I7» 



While a limited partner is under no obligation to 
contribute his share of losses— such share being merely 
charged against him— he is liable to pay back to the 
firm any part of his capital that may be w^ithdrawn by 
him. 



■ 



If he knowingly withdraws his Capital, the position 
is clear ; but there might be more difficult cases in which 
he inadvertently did so. He might, for example, draw 
fixed sums at periodical intervals against accruing 
profits. Profits are ordinarily ascertained over periods 
fixed by the agreement of the partners. A limited partner 
may, up to some date in that period to which profits have 
in fact been made, make drawings against them, but the 
accounts for the whole period may show a loss — that is, 
tiie loss for the period subsequent to the date at which 
drawings ceased to l^e made may exceed the profits up 
to that date. Has the limited partner in these circum- 
stances " received back " any part of his Capital in the 
sense of the Act? There can be no " profits " except 
such as appear from an account properly taken, and it 
is submitted that the "profits" which may be with- 
drawn are those appearing upon the accounts as 
prepared at the usual periods and according to the 
customary practice .of the firm. If, upon those accounts, 
it appears that drawings exceed the profits, there has 
been a withdrawal of Capital, unless a Loan Account 
exists, which may then (b\' agreement) be taken to be 
reduced bv the amount withdrawn. 



172 



PARTNERSHIP ACCOUNTS. 



A limited partner must necessarily be dependent to a 
great extent upon the general partner or partners as to 
the amount of profits to which he may be entitled. He 
may receive as his share of profits an amount which, 
owing to a mistake— intentional or otherwise— in the 
preparation of the accounts, in whole or in part repre- 
sents Capital. 



A limited partner need not, however, accept the 
accounts of the partnership as prepared without inquiry. 
He is, by the express provisions of the Act, entitled to 
inspect the accounts by himself or his agent, and, 
although he has no rights as regards management, he 
may advise with the general partners upon the state 
and prospects of the partnership business. A limited 
partner should not, therefore, rely entirelv upon :he 
general partners for the correctness of the accounts, and 
must take steps to satisfy himself as to their general 
accuracy. 



INDEX. 



PAGE 
lO, II 

10 

8-9 



Account, Books of, generally 

,, Right of partners to inspect 

Accounts, Obligations as to keeping 

„ how far binding upon the partners 

„ when to be prepared 

Admission of a partner 

Advances by partners 

,, interest thereon 

„ repayment of ••■ ■•• ••• •■• ••• 5' 

„ by a limited partner 

Agreement, Partnership 

Application of assets upon dissolution, Order of 

interim distributions to partners 

Assets, Valuation of, for purposes of annual or periodical 

accounts ... ••• ••• ••• ••• ■•• ..-i^, 21-24 

upon dissolution "^'^j Si-84, 90, 93-97 



24. 25 

XI 

63-66 

S 

5. 46 

109, III 

168, 169 

1-7 

109-111 

112-iit; 



»> 



ti 



appreciation of 
where unrecorded 



Balance Sheet, generally 

ascertainment of profits from 

creditor has no right to inspect ... 

example of ... 

reserves in 

valuation of assets for purposes of 






j> 



■• 38-39 
39 

19-25 
13-14 

25 
5-6 

19-20 

...12, 21-24 



Capital, Alteration of Shares in 4-5» ^^» 57 

Distinction from Advances and Current Accounts ... 47 

Interest on 5» 4^ 

Losses of, to be contributed by partners 4, 27, 2S-29, 103-105, 

115, 116 

No obligation upon partners to contribute 4 

Opening entries in respect of ^4j I"-i7 

Shares in ^ 



a 



)i 



»» 



»» 



174 



INDEX. 



Current Accounts 

Death of a Partner. {Scg Outgoing Tanner.) 

Deficiencies of Capital. (See Capital, Losses of, and Insolvency 

of one Partner.) 
Dissolution as to one Partner 

*'■ "•• ••• ••• 

as to all Partners 

'** ''•' ••• ■•* 

advances by a Partner after ... 

••• •«• ... 

Form of Accounts upon 

how caused 

• "*• ••• ... 

Drawings, Agreement as to amount of 

$, how treated in Accounts 

„ Interest on 



PAGE 

6,47 






Ei/ioa v. Elliott 

Garner v. Murray 

Goodwill, as an unrecorded asset 

treatment in accounts upon dissolution 



3» 



»> 



„ periodical Accounts of a Partnership 



... IIO-UI 

73-74 J 76, 122-125 

7-2 73 

• • • « • • 4^ 

46, 126 

... ^o 

122-127 

117-122 

30-40 

77 
62-71 

126-127 



Income-Tax, generally 
;j Appeals 



»» 



Apportionment of Tax 

Assessment upon Firm 

Employee admitted as a Partner 

Firm's Return 

Losses, Claim in respect of ... 

New Business 

Partners' Claims 

„ Returns 

Schedule A 

• ••• ••• ... 

Succession Rule • 

Insolvency of one Partner, Apportionment of Loss to others 

consequent upon 

Interest on Advances 

<^«pital 

Current Accounts 
Drawings 

o ••• ••• ... 



J5 
»» 

s> 
ft 

19 



... 128-161 

M4-M7 

i^q, 142, 157 i^ I 

— »33-i3^. M3 

... ... 1 S^2 

... 13^ 

... 1 s;2-i ;6 
• •• ... '47" ^4^ 
132, 138-130, 140-141 

^Z^-^Z^-^ 140-141 

129 

149-152 



59 



3> 



S) 



Capital, how calculated 



115, 117-122 

... 46 

40 

47 
... 46 

4 £5-46 



INDEX. 



175 



PAGE 

Interest how apportioned in Accounts 4i-44 

„ no Interest after Dissolution ^^^ 

Investments, Valuation of, for purposes of Periodical Accounts 23-24, 29 

upon Dissolution ... ••• ••• ^^ 

Apportionment amongst Partners at Valuation 106-108 



9> 



11 
9] 
Jl 



Limited Partnerships, Accounts of 162-171 

Advances of Limited Partners 168-169 

Capital Contribution of Limited Partner 163 
Contributions towards losses of... 164-165, 167 

Accounts upon Dissolution of 169 

Limited Partner has right to inspect 

Accounts of ... ... ••• ••• 17* 

Limited Partner has no power of 

management 164 

Limited Partner may withdraw Profits 165-168 
„ may not receive back 

Capital 170 

Particulars to be registered ^ 163 

Position of General Partner in 165-168 

Losses of the Firm, Apportionment of 27 

Contributions toward.. 28-29, 103-105, 115, 116 






91 

»9 



11 



Nowell V. Noxvell 

Opening Entries 

Outgoing Partner, Ascertainment of amount due to 

„ Interest of, in Goodwill 

„ Payment of amount due to 

Partners, General, Dormant, Limited 

„ Obligations of General, in respect of Capital 

„ ,, services 

,, in regard to losses ... 



11 

19 



91 
91 
it 
99 
11 



Obligations of, in Limited Partnerships 
Rights of General, in respect of Advances 
,, „ Capital 

., „ Current Accounts 

„ ,, Drawings ... 



91 



Profits 



103-104 

.14, 16-17 
78-97 

77 
91-92 

X 

3 

3 

4 
. 164-169 

5 

4-7 

6 

4-7 

4-7 



t :i 



176 



INDEX. 



Partnership Propert}- 



ft 



PAGE 
•• ••- ... 3 

Interest of Partners in 6-7, 63-64 

Partnership in, ceases at Dissolution ... 108 

Policy of Assurance, Apportionment of Value between 

Interests of successive Partnerships 

Profit and Loss Account ... "• ^3 97 

••• ••• ••• ••• ... 26-61 

Profits, Ascertainment of ... ^ ^ 

„ Allowance for Interest on Capital .q 

Partners' Salaries ... .-, ^, 

40-4.1 

Salary to one Partner out of another 

Partner's Share 
T-^'-- ■" •'• 42"44 

Division of 

27,40-42,47 



If 



9$ 



»» 



»i 



93 



Drawings on account of 

Entries upon Apportionment of 

Error of Principle in ascertaining 

Estimates made in ascertaining 

Revenue and Capital, no distinction between as 
regards rights of Partners 

"•• ••• ■■• 



4> 5»6 
15.29 

30-33 
37 

26 



Reserves 

Realisation Account 



— 19-20,34-36 

100, 102 

Apportionment of result of loi, 103-105 

Revaluation of Assets in arriving at amount due to Outgoing 



f» 



Partner 

--- 

Salaries, Agreement for 

■ ••• ••• ... ... 

how borne by Partners tnUr se 

of one Partner, out of another Partner's share 
Single Account System of ascertaining Profits 
Stock-in-Trade, Valuation of " 

Trial Balance 



» 



j> 



84-89 

40 

41-44 
42-44 

13 
21-22 

5^ 



\ 



li 



V 



1 I ; I ; yj 



14 wn 





Date Due 




7idk:il,3JL4- 




1 


v-*^ 


HT?' 




1 


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37? 








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1965 






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Dawson 

Partnership accounts • 



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ll^ 



FEB 2 S1994 



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END OF 
TITLE